Transfer Pricing News

CONTENTS ▶ INTRODUCTION

▶ BELGIUM Transfer pricing and customs: a forced marriage

▶ KUWAIT Key changes relating to transfer pricing impacting foreign companies operating in Kuwait

▶ NETHERLANDS Tax ruling practice regulations updated

New country-by-country-reporting rules for banks and investment firms

▶ SWITZERLAND Changes to principal companies requirements

▶ UNITED KINGDOM Transfer pricing reporting

UNITED KINGDOMTransfer pricing reporting

READ MORE 9

BELGIUMTransfer pricing and customs: a forced marriage

READ MORE 2

THE NETHERLANDSTax ruling practice regulations updated

READ MORE 6

JULY 2014 ISSUE 15 WWW.BDOINTERNATIONAL.COM

TRANSFER PRICING NEWS

INTRODUCTION

We are very pleased to bring you this 15th issue of BDO’s Transfer Pricing News, which we were able

to produce in close co-operation with our colleagues from the countries mentioned below.

Transfer pricing is increasingly influencing significant changes in tax legislation around the world. This issue of Transfer Pricing News focuses on recent developments in the field of transfer pricing in Kuwait, the Netherlands and Switzerland. It also includes an interesting article on country-by-country reporting and an article from BDO Belgium about a conflict of interest between transfer pricing and customs.

We trust that you will find it useful and informative. If you would like more information on any of the items featured, or would like to discuss their implications for your business, please contact the person named under the item(s). The material discussed in this newsletter is intended to provide general information only, and should not be acted upon without first obtaining professional advice tailored to your particular needs.

2 TRANSFER PRICING NEWS N° 15

BELGIUMTRANSFER PRICING AND CUSTOMS: A FORCED MARRIAGE

Due to globalisation and the ensuing frequency of international transactions, the importance of transfer pricing

in the customs environment has significantly increased. Tax and customs administrations, even within one country and sometimes within the same government department, have different approaches. Specifically, tax authorities focus on intra-group sales prices that may be perceived as higher than they should be, while customs authorities verify imported goods for which prices may be perceived as lower than the market price. While both administrations seek to achieve the same goal, i.e. arm’s length pricing, customs and tax examinations are forced to follow different regulations and may have conflicting interests.

Transfer pricing: basic conceptsThe basic principle in transfer pricing is the arm’s length principle as described in the OECD Transfer Pricing Guidelines. The transfer price between related parties impacts the profitability of the different entities and hence the tax revenues for the different countries. Local tax authorities seek conformity with the “arm’s length principle” for intercompany transactions in order to safeguard local tax revenues. The arm’s length principle is based on the OECD guidelines, which form the basis of bilateral tax treaties involving OECD member countries and an increasing number of non-member countries and states: “[Where] conditions are made or imposed between the two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”

The OECD Transfer Pricing Guidelines also describe specific methods to determine transfer prices, with the transactional net margin method being most commonly used. Finally, many countries have issued guidelines on the transfer pricing documentation used to substantiate and justify transfer prices for goods, services, intangibles, finance transactions, etc.

Customs valuation: basic conceptsCustoms valuation is based on the General Agreement on Tariffs and Trade (GATT)/World Trade Organisation (WTO) Valuation Code. The GATT/WTO Valuation Code definition of “customs value” forms the basis on which WTO members have drafted the definition of customs valuation in their own customs legislation. In the European Community, the basic customs valuation rules and definitions are found in Articles 28-36 of the Community Customs Code and in Articles 141-181 and Annexes 23-29 of the Community Customs Code Implementing Provisions.

In determining the customs value, different methods are defined which need to be used in hierarchical order. The primary method is the transaction value of the imported goods. Here, the transaction value of imported goods between related parties can only be accepted if it can be demonstrated that the price of the imported goods is at arm’s length. Furthermore, this transaction value must be adjusted under certain specific conditions.

Customs and transfer pricing: conflict of interestBoth tax and customs administrations often set rules independently for the same transaction and/or goods. Tax authorities seek conformity with the OECD Transfer Pricing Guidelines which have been put in place in many countries, whereas customs authorities conform to Article VII of the GATT Valuation Code.

Identify the main income tax charge

Entity based

Royalties

Overhead

Financing costs

Selling price

Marketing

costs

Compensation

payments

Provided

materials

Management

fees

Identify the main customs charge

Product based

Transfer pricing view Valuation view

3TRANSFER PRICING NEWS N° 15

This different approach to transfer pricing and valuation creates an atmosphere of uncertainty and complexity. It also leads to increased implementation and compliance costs, an absence of flexibility in conducting business operations, and last but not least creates a significant risk of penalties. In fact, even when a company complies with both the OECD guidelines/principles and the WTO Valuation Agreement there is no guarantee that there will not be a dispute between two countries or two administrations in the same country regarding the determination of the arm’s length price. This means that valuation conflicts can arise not only prior to, but also after, an audit.

Given the significant increase in the volume and complexity of intercompany transactions, the divergence in customs and transfer pricing valuation presents an obstacle to the liberalisation of trade and it inhibits international development for companies of all sizes.

The table below provides a summary of the factors highlighting the differences between transfer pricing and customs valuation.

Factor Transfer pricing Customs valuation

Taxable event Sale or purchase of the goods Importation of goods into the country

Rationale Avoiding shifting of income Modelling of international trade

Relevant time for assessing value Date of sale or purchase Date of importation

Time of audit Year(s) after the sale transaction Time of importation or years after the transaction

Goals pursued by authorities Decrease in value Increase in value

Customs

Parent company

Income tax question Is TP arm’s length?

BE perspective TP too high?

From USA perspective TP too low?

Sales tax question From BE perspective:

Import VAT, delivery of tangible goods taxable? Input tax deduction authorization?

Customs question Is the delivery subject to customs?

If so: what is the appropriate customs value?

BE perspective TP (as customs value) too low?

SubsidiaryDelivery TP = 100

Conflict of interest


Case studyA common situation where transfer pricing may trigger customs issues relates to a retrospective adjustment of the transfer price paid for goods in a cross-border situation. Suppose you are a company acting as a limited risk distributor based in China and you purchase and import goods from a related company in Belgium. The distribution activities will be remunerated using the transactional net margin method with a target operating margin on sales. At the beginning of the year, the transfer prices will be set based on budgets provided by the Chinese entity. Hence, products will be imported based on the budgeted transfer price.

Schematic overview of the flows:

CustomerPrincipal Co Limited risk

distributor

Residual profit

Target operating margin

Physical flow

Invoice flow

Service flow

Bookkeeping services

Sale of finished goods

At the year-end (or more frequently), a transfer pricing adjustment is made to bring the actual operating margin realised by the Chinese distributor in line with the target operating margin.

From a customs point of view, the year-end adjustment will involve a correction to the declared customs value of the import transactions affected by the year-end adjustments. If the price is adjusted upwards, both the customs value and the amount of customs duties will increase. If the price is adjusted downwards, the effect will be the opposite: both the customs value and the amount of customs duties will decrease. In the former situation, the customs authorities will expect a regularisation of the declared customs values and additional customs duties to be paid. In the latter situation, the importer may be entitled to a refund of customs duties. Furthermore, in such cases of structural year-end adjustments it is advisable to conclude a customs valuation agreement with customs to agree on the frequency, timing and methodology for these adjustments.

ConclusionTwo different valuation regimes applicable to the same transactions forces importers to take into account the consequences of transfer pricing methodologies when assessing customs valuation. It is highly recommended to review pricing methodologies and agree with the customs administration on the procedure to be used to reassess or confirm the customs valuation of imports in an efficient and compliant manner.

By Pieter Haesaert, customs expert and by Tine Slaedts, transfer pricing partner at BDO Belgium.

Your BDO contacts in Belgium: TINE [email protected]


KUWAITKEY CHANGES RELATING TO TRANSFER PRICING IMPACTING FOREIGN COMPANIES OPERATING IN KUWAIT

The Kuwait Income Tax Department recently issued a revised set of Executive Rules and Regulations (the Executive

Rules) which apply for tax periods ending on 31 December 2013 and thereafter. The revised Executive Rules include the following changes relating to transfer pricing which will affect foreign companies operating in Kuwait.

– Deductions for imported materials will be restricted as follows:

a) Materials imported from head office: a maximum of 85% of the corresponding revenue from the imported materials (previous limit was 85% to 90% of corresponding revenue).

b) Materials imported from related entities: a maximum of 90% of the corresponding revenue from the imported materials (previous limit was 90% to 93.5% of corresponding revenue).

c) Materials imported from third parties: a maximum of 95% of the corresponding revenue from the imported materials (previous limit was 93.5% to 96.5% of corresponding revenue).

– Deductions for the cost of design work carried out outside Kuwait will be limited to:

a) 75% of the design revenue, for design work carried out by head office (previously the limit was 75% to 80%).

b) 80% of the design revenue, for design work carried out by related entities (previously the limit was 80% to 85%).

c) 85% of the design revenue, for design work carried out by third parties (previously the limit was 85% to 90%).

– Deductions for the cost of consultancy work carried out outside Kuwait will be limited to:

a) 70% of the consultancy revenue for costs related to work carried out at the head office (previously the limit was 70% to 75%).

b) 75% of the consultancy revenue for costs related to work carried out by related entities (previously the limit was 75% to 80%).

c) 80% of the consultancy revenue for costs related to work carried out by third parties (previously the limit was 80% to 85%).

– Deductions for lease/rental costs of assets leased from the head office, subsidiaries and related entities will be limited to the depreciation charge on the corresponding assets, based on the tax depreciation rates specified in the Kuwait tax regulations.

Your BDO contact in Kuwait: QAIS M. AL [email protected]

Your BDO contacts in Kuwait: RAMI [email protected]


NETHERLANDSTAX RULING PRACTICE REGULATIONS UPDATED

On 12 June 2014 the Dutch Ministry of Finance released five decrees as an update to the existing 2004 tax

ruling policies. These include decrees relating to substance requirements, advance pricing agreement (APA) requests and advance tax ruling (ATR) requests. The decrees are in line with the 2004 tax ruling policies. We highlight the key points below.

1. Substance requirementsSince 2004 there has been a policy decree on the basic substance requirements for Dutch intermediary companies engaged in intra-group royalty and financing activities. The 2004 decree applied to financial services entities seeking an ATR or wishing to conclude an APA with the Dutch tax authorities.

From 1 January 2014, the Dutch substance rules for financial services entities have been laid down in Dutch tax law. These basic substance requirements are now also applicable for financial services companies that do not seek prior confirmation by means of an APA or ATR with the Dutch tax authorities, but wish to make use of the Dutch tax treaty network or the EU Interest & Royalty Directive (including its local implementation).

The new decrees follow the extended financial service company definition as applicable for the basic substance requirements. This implies that companies, 70% or more of whose activities consist of intercompany financing, licensing, rental and leasing, are considered financial service companies. The new policy decrees give some further guidance on the interpretation of these basic substance requirements. Some important aspects are listed below.

– Supervisory directors can be excluded in determining whether or not at least half of the directors are Dutch resident;

– The requirement that board decisions are taken in the Netherlands implies that regular board meetings must be held in the Netherlands with the physical presence of directors. During these meetings important decisions must be made. The decision making process must go beyond the mere formalisation of decisions already taken outside the Netherlands;

– As regards bank accounts, it is not required that they are held with a Dutch (resident) banking institution;

– Under the basic substance requirements the book-keeping should be done in the Netherlands. If the group operates a centralised bookkeeping function, the substance requirements can still be met if there are sufficient operational activities in the Netherlands.

2. APA/ATR The requirements for concluding an APA/ATR are in line with the 2004 ruling policies. An APA/ATR may now apply for a longer term (5 years); this may be extended in the case of long term contracts. To be able to apply for an APA or an ATR a company must meet the basic substance requirements or have the genuine intention to meet these requirements. For financial service companies applying for an APA there is an additional element. If such companies only meet the basic substance requirements and the group does not have any other activities in the Netherlands, nor does the group have any genuine plans to increase their substance in the Netherlands, then the Dutch tax authorities will spontaneously exchange information about the APA.

Requests for an ATR and an APA need to be filed with the competent tax inspector of the taxpayer, with a copy of the request to be sent to the APA/ATR Team in Rotterdam. The new decree on the ATR explicitly lists eight situations in which the competent tax inspector needs to request binding advice from the APA/ATR Team in Rotterdam. A binding advice is required for:

– Application of the participation exemption for intermediate holding companies and top holding companies with subsidiaries without any business activities in the Netherlands;

– Hybrid financing or hybrid entities in international structures;

– Confirmation whether there is a permanent establishment in the Netherlands or the BES Islands (Bonaire, Saba and Sint Eustatius);

– Substantial interest for non-resident taxpayers;

– Allocation of shares to a permanent establishment in the Netherlands or the BESIslands;

– Confirmation whether there is a Dutch business enterprise under the rules for non-resident taxpayers;

– Dutch dividend withholding tax position for Cooperatives.

– The application of discretionary relief (“vangnetbepaling”) under any Limitation of Benefits articles in a bilateral tax treaty also needs to be filed with the APA/ATR Team in Rotterdam as well.

The new decrees apply from 13 June 2014.

Your BDO contact in the Netherlands: HANS [email protected]

Your BDO contact in the Netherlands: SJOERD [email protected]


NEW COUNTRY-BY-COUNTRY-REPORTING RULES FOR BANKS AND INVESTMENT FIRMS

The European Capital Requirements Directive (2013/36/EU), published in 2013, introduced a new governance

framework for the supervision of banks and the Basel III capital requirements to European law. In order to incorporate these regulations into Dutch law, a decree has been drafted and submitted to the Second Chamber of Parliament on 28 April 2014.

Under the decree, the following information should be reported on a country-by-country basis:

1. Name, nature of activities and geographical location;

2. Revenue;

3. Average number of full-time employees;

4. Profit or loss before tax;

5. Tax on the profit or loss; and

6. Government subsidies received.

If possible, this information should be published together with the annual accounts or the consolidated accounts of the entity either included in the accounts or with a reference to where and when this information is published.

This decree suggests country-by-country reporting for banks and investment firms whose accounting year started on or after 1 January 2014.

In addition to this, the following information has to be published/submitted by 1 July 2014 regarding the previously closed accounting year (on or after 1 January 2013):

– Banks and investment firms have to publish information regarding point 1, 2 and 3 above; and

– Banks or investment firms which have been registered by the Financial Stability Board as globally system-relevant are required to provide information on the above points 4, 5 and 6 on a confidential basis to the European Commission and the Dutch Central Bank.

Another requirement in the decree is the publishing of the return on assets, i.e. the net realised profit on the total assets, for accounting years starting on or after 1 January 2014, which also applies to statutory accounts.

The introduction of country-by-country reporting (“CBCR”) for banks and investment firms is one of numerous regulations for more financial supervision on a global basis. Broader CBCR requirements will follow considering the OECD Discussion Draft on Transfer Pricing Documentation and Country-by-Country requirements which was published on 30 January 2014 as one of the actions of the OECD against base erosion and profit shifting. CBCR should give tax authorities an additional risk assessment tool to understand the financials of multinationals and where their key value drivers are located. The OECD plans to publish final country-by-country reporting rules in autumn 2014 for the local countries to incorporate them into national law.

These developments are moving fast and tax payers are advised to start getting prepared for the additional compliance requirements and ensure that their transfer pricing model (transactions between and arm’s-length remuneration of group entities) is in line with their business model.

Your BDO contact in the Netherlands: SJOERD [email protected]

Your BDO contact in the Netherlands: CARINA [email protected]


SWITZERLANDCHANGES TO PRINCIPAL COMPANIES REQUIREMENTS

The Swiss Federal Tax Administration (SFTA) has issued new instructions to the Swiss cantons on the tax treatment

of principal company structures, which include a Swiss principal company and foreign distribution companies. Under the principal company regime, a percentage of profits is not subject to Swiss tax, and the SFTA wishes to prevent abuse of the profit allocation mechanism.

New rulesThe main new requirements are that:

– Affiliated foreign distributors must distribute goods exclusively on behalf of the principal company, and must be economically dependent on it, which will be the case if at least 90% of their income relates to the principal company’s business;

– The gross margin of distributors must not exceed 3% of sales or higher costs; and

– Key trading functions and risks must be allocated to the principal company, and not outsourced.

ImplicationsThe new requirements must be met by 2015/16 for existing principal companies, but they are immediately effective for all new applications. If the new requirements are not met, the effective tax rate may be increased, reducing the benefit of the principal company regime.

In the case of existing principal companies, failure to meet the new requirements could result in adjustments for previous years.

Action requiredThe cantons will be reviewing principal company structures, and deciding whether any tax rulings need to be amended, or changes need to be made to arrangements if a structure is to comply with the new rules. Existing and proposed principal companies will therefore need to review distributors’ activities and gross margins, and the allocation of key functions and risks, and make any necessary changes in order to continue to qualify for principal company treatment.

Your BDO contacts in Switzerland: THOMAS [email protected]


UNITED KINGDOMTRANSFER PRICING REPORTING

The Organisation for Economic Co-operation and Development (OECD)’s planned introduction of country-by-

country reporting and stricter transfer pricing documentation requirements will greatly increase the transparency of businesses’ value chains. It will also mean that businesses will need to compile the required data effectively. Action is recommended now to test reporting capabilities and maximise the time to address shortcomings and potential tax exposure.

BackgroundThe OECD recently released its updated discussion draft on Transfer Pricing Documentation and Country-by-Country Reporting as part of its ongoing review of base erosion and profit shifting (BEPS) in the international tax system. This will result in a major change in the way that multinational enterprises (MNEs) document their transfer pricing policies. These proposals will:

– Greatly increase transparency for local tax authorities through the inclusion of country-by-country (CbC) reporting of key financial metrics across a group; and

– Raise the bar for the level of analysis required in transfer pricing documentation and the frequency of its review and updating.

As documentation is a key part of transfer pricing risk assessment, meeting these requirements will be critical to preventing or rebutting more onerous tax enquiries or audits and the transfer pricing adjustments or penalties that could result.

Country-by-country reportingMNEs will be expected to report specified business and financial data by country and entity following a template proposed by the OECD. This will include:

– Classification of business activities

– Revenues

– Earnings before income tax

– Income taxes paid on a cash basis (to local and other countries)

– Withholding tax paid

– Stated capital and accumulated earnings

– Number of local employees and related total employee costs

– Tangible assets

– Intercompany payments and receipts of royalties, interest and service fees.

The OECD may add to this list as part of its consultation process.

Providing immediate visibility of how a local entity performs within a group, the respective importance of its local personnel in terms of average reward, and the size and direction of its intercompany transactions will make it easier for tax authorities to identify and challenge potential weaknesses. It will allow tax authorities to assess risk by using a comparison of country results or applying a formulaic approach at the expense of the arm’s length standard.

Businesses will need to be confident that:

– Transfer pricing policies are set appropriately and any variations between entities are addressed and supported;

– Policies are implemented effectively and that local results are in line with expectations; and

– It is possible and practical to meet these reporting requirements, for example that accounting systems can provide quality data in a timely way.

CbC requirements will not be limited to large MNEs. Tax authorities will have the ability to request CbC reporting from SMEs as part of their risk assessment or tax audit procedures.

Transfer pricing documentationThe OECD seeks transfer pricing documentation that is comprehensive for tax authority risk assessment purposes. The existing standard in Chapter V of the OECD Guidelines on Transfer Pricing is, therefore, being replaced. The proposed key changes include:

– An emphasis on contemporaneous documentation rather than “justifications for positions after the fact”, requiring the preparation of documentation and supporting evidence in advance of the filing of the tax return – in practice twelve months from the year end;

– An understanding that all relevant documents in an MNE’s possession will be available on the request of tax authorities, regardless of whether it is in the possession of the local entity;

– A two-tier approach of a central ‘masterfile’ and supporting local country files, alongside CbC reporting increasing the transparency of the global position for local tax authorities;

– An assumption of annual review and update of transfer pricing documentation, with an expectation of a three-yearly refreshing of comparables benchmarking in the absence of business changes in the interim;

– An assertion that local comparables should be used where reasonably available, rather than regional comparable data; and

– The provision of additional specified information.

The OECD is keen for tax authorities to focus on the materiality of transactions, although this is currently set out in terms of the size of the local economy as well as materiality for the business. This is a clear indication that tax authorities are focusing on a more stringent review at the risk assessment stage of a transfer pricing enquiry and that their expectations for compliance will be higher than at present. Robust documentation will be a critical part of achieving a low-risk rating and preventing more detailed enquiries.

RecommendationsAlthough the OECD’s proposals are in draft at present, significant changes before implementation are unlikely. Based on the OECD’s Base Erosion and Profit Shifting Action Plan, the proposals will be finalised by September 2014, and we expect that tax authorities will require them to be followed for subsequent tax return filings. So we recommend that businesses:

– Test and confirm the ability of their systems to meet CbC reporting requirements;

– Conduct a ‘dry run’ of CbC reporting to review the outputs for unintended or unexpected outcomes and tax and transfer pricing risk; this might be combined with wider process testing, for example for Senior Accounting Officer purposes;

– Address any shortcomings identified in the group’s transfer pricing policy and implementation ahead of the tax filing process;

– Test existing documentation against the updated masterfile and countryfile requirements of the Draft;

– Ensure that comparables analysis and benchmarking data is up to date; and

– Put in place an implementation programme for local country files where these do not already exist.

Where these actions identify potential weaknesses in the business’ transfer pricing policy, implementation or documentation, steps should be taken to address these at the earliest opportunity. Effective remedies may not be possible if this is left until the tax return filing process following the year end.

Your BDO contact in United Kingdom: ANTON [email protected]

Your BDO contact in United Kingdom: DUNCAN [email protected]


This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained herein without obtaining specific professional advice. Please contact the appropriate BDO Member Firm to discuss these matters in the context of your particular circumstances. Neither the BDO network, nor the BDO Member Firms or their partners, employees or agents accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

BDO is an international network of public accounting firms, the BDO Member Firms, which perform professional services under the name of BDO. Each BDO Member Firm is a member of BDO International Limited, a UK company limited by guarantee that is the governing entity of the international BDO network. Service provision within the BDO network is coordinated by Brussels Worldwide Services BVBA, a limited liability company incorporated in Belgium with its statutory seat in Brussels.

Each of BDO International Limited, Brussels Worldwide Services BVBA and the member firms of the BDO network is a separate legal entity and has no liability for another such entity’s acts or omissions. Nothing in the arrangements or rules of the BDO network shall constitute or imply an agency relationship or a partnership between BDO International Limited, Brussels Worldwide Services BVBA and/or the member firms of the BDO network.

BDO is the brand name for the BDO network and for each of the BDO Member Firms.

© Brussels Worldwide Services BVBA, July 2014 1407-04

LIST OF CONTACT PERSONS

Dan McGeownInternational Tax DepartmentBDO Toronto

TelFaxe-mail

+1 416 369 3127+1 416 865 [email protected]

Dirk ElbertInternational Tax DepartmentBDO Frankfurt am Main

TelFaxe-mail

+49 69 95 941 438+49 69 95 941 [email protected]

Michiko HamadaInternational Tax DepartmentBDO New York

TelFaxe-mail

+1 212 885 8577+1 212 697 [email protected]

Sjoerd HaringmanInternational Tax DepartmentBDO Rotterdam

TelFaxe-mail

+31 10 242 4600+31 10 242 [email protected]

Anton HumeInternational Tax DepartmentBDO London

TelFaxe-mail

+44 207 486 5888+44 207 487 [email protected]

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