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Transfer Pricing News

Welcome to the first edition of Grant Thorntons Transfer Pricing News.
This issue contains transfer pricing updates from a number of countries across the globe a necessity in the global economy we all now inhabit. So if you want to know about new developments in transfer pricing around the world this is the place to look. To find out more about the topics featured in Transfer Pricing News do not hesitate to get in touch with the Grant Thornton transfer pricing team. The contact details are included on the last page of this newsletter.
This information has been provided by member firms within Grant Thornton International Ltd, and is for informational purposes only. Neither the respective member firm nor Grant Thornton International Ltd can guarantee the accuracy, timeliness or completeness of the data contained herein. As such, you should not act on the information without first seeking professional tax advice.

Go to page 2 3 5 8 9 Argentina Australia Canada China India

11 Italy 13 Japan 14 Mexico 16 Netherlands 17 Poland 18 Russia 22 South Africa 23 Spain 24 United Kingdom 26 Whos who
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Argentina

Recent changes

The Argentinean tax authorities recently introduced new information reporting requirements. The new annual transfer pricing information return form (F.969), extends the information required by the original F.743 form, that will remain in place. The new annual form must be filed within 15 days of the income tax returns due date and is effective retrospectively for tax years ending on or after 31 December 2010.

The new annual form will require a detailed account of all transfer pricing related information in respect of exports, imports and other transactions. The information included in any of these transfer pricing reports that is not in Spanish must be accompanied by a signed translation performed by a sworn and registered Argentinian translator.
Fernando Fucci Grant Thornton Argentina E fernando.fucci@ar.gt.com

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Australia

2012 is expected to be a watershed for Australian transfer pricing

In recent years, the Australian Taxation Office (ATO) has focused heavily on the enforcement of Australias transfer pricing rules. This focus is expected to intensify in 2012 as a result of two major developments: 1. The initiative of the federal government to reform Australias transfer pricing rules for multinational companies 2. The introduction by the ATO of a new International Dealings Schedule (IDS) that will replace Schedule 25A and the Thin Capitalisation Schedule (TCS).

The introduction of the new IDS and the proposed changes to the transfer pricing rules represent a big step towards the ATOs aim of implementing a more sophisticated risk assessment and mitigation framework.
Proposed changes to Australias transfer pricing rules

The government initiative is a response to the federal courts recent finding against the ATOs approach to transfer pricing cases. The federal court rejected the ATOs use of the transactional net margin method in favour of the taxpayers comparable third party transaction information. The court highlighted discrepancies between Australias transfer pricing legislation and the ATOs application of the arms length principle, which favours using traditional transaction transfer pricing methods to price intercompany dealings.

Included among the proposed changes to Australias transfer pricing regulatory framework are the endorsing and regulating of the OECD guidelines; incorporating the arms length principle into law; and limiting the existing discretionary powers of the tax commissioner to determine the arms length outcome for intercompany dealings. Also proposed are legislative and treaty amendments for moving to a functionally separate entity for the attribution of profits to a permanent establishment. In addition, taxpayers with certain volumes of intercompany dealings will have a statutory obligation to prepare contemporaneous documentation, and establish processes to set and review their transfer prices.

The governments intention to endorse profit allocation rules as part of the new transfer pricing regulatory framework in Australia has been of particular interest to the taxpayers as it will limit the erosion of the Australian tax base. This is in contrast with guidance provided by the OECD that recommends the application of the arms length principle to ensure that the terms and conditions of intercompany dealings are the same as those expected to be agreed between non-related parties. At the moment it is a case of watch this space with draft legislation expected to be released soon.

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New international dealings disclosure requirements

The introduction of a new income tax schedule for international dealings establishes the framework for the ATOs strategy of closely monitoring taxpayers international dealings. When completing the new IDS, taxpayers should expect to provide greater levels of detail in disclosures concerning international dealings (as opposed to previous Schedule 25A and TCS), and consequently, an increase in the resources and time invested in preparing this schedule. In addition, the new IDS form is reflective of the ATOs greater emphasis on the responsibility of a companys public officer to ensure that international dealing disclosures are completed accurately and are supported by bona fide information.

On the other hand, taxpayers should expect that with the introduction of the new IDS the ATO will be able to apply a more systematic and analytical approach to review a taxpayers international dealings. As a result, a proliferation of targeted transfer pricing reviews and audits initiated by the ATO is anticipated.

Conclusion

The message is clear the ATO is looking closely at a taxpayers international related party dealings, supported by greater disclosure requirements, more sophisticated scrutiny tools and the adoption of a transfer pricing regulatory framework that is in line with international best practice.

Although greater consistency with trading partners in the international dealings arena will be viewed as a positive development for Australia, taxpayers are advised to be prepared for the new international dealings environment and review their policies and practices, as well as ensuring that the appropriate documentation and support are in place.
Jason Casas Grant Thornton Australia E jason.casas@au.gt.com

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Canada

Straight from the source Canadas first supreme court transfer pricing case

On 13 January 2012, arguments were heard by the supreme court of Canada in the matter of Her Majesty the Queen v. GlaxoSmithKline Inc. The case involves the pricing of intercompany transactions between Glaxo Canada, a Canadian corporation, and related corporations in the United Kingdom and Switzerland, Glaxo Group Ltd. (Glaxo Group) and Adechsa S.A. (Adechsa), respectively, during the 1990 to 1993 tax years.

As this is the first international transfer pricing matter to be considered by Canadas highest court, we find it instructive to consider the issues and questions on which the Justices seemed to focus during the hearing. Such an analysis may be useful in shedding light on the possible future of the arms length principle in Canada.
Background

In 1972, Glaxo Canada entered into a consultancy agreement with Glaxo Group which granted Glaxo Canada access to various services and intangibles, including the right to manufacture, use trademarks of and sell certain Glaxo Group drugs. Glaxo Canada, in turn, paid a 5% royalty for these rights.

In 1976, Glaxo Group discovered ranitidine, the active pharmaceutical ingredient used in the manufacture of the branded compound Zantac, a drug used for the treatment of stomach ulcers. In 1988, the consultancy agreement was replaced with a licensing agreement to explicitly include the provision for services and intangibles related to Zantac. In return for these services and intangibles, Glaxo Canada paid a 6% royalty on net sales. In 1987 and 1989, two independent drug companies Apotex Inc. (Apotex) and Novopharm Ltd. (Novopharm) began selling generic ranitidine products in Canada.

Both Apotex and Novopharm purchased their ranitidine from unrelated manufacturers at significantly lower prices (approximately 80% less) than the prices charged by Adechsa. The unrelated manufacturers did not hold any patents and were not Glaxoapproved sources of ranitidine. In 1993, Glaxo Canada was audited, and in 1996 the minister reassessed Glaxo Canada for the taxation years in question and increased Glaxo Canadas taxable income for each of the years pursuant to subsection 69(2) of the Income Tax Act (the Act). The reassessment pertained to the supply agreement only.

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In 1998, Glaxo Canada appealed to the tax court of Canada (TCC) and the dispute proceeded to trial. Subsection 69(2) was in effect in the taxation years at issue, though the statute has since been repealed and replaced by Section 247.
TCC decision

FCA decision

In the TCCs judgment on 30 May 2008, the presiding Justice Rip agreed with the crown courts approach and concluded that Glaxo Canada had overpaid Adechsa for ranitidine. He determined that the prices Glaxo Canada had paid to Adechsa were not reasonable in the circumstances, as Glaxo Canada could have obtained ranitidine from generic manufacturers at substantially lower prices. Glaxo Canada appealed the decision of the TCC to the federal court of appeal (FCA).

In the FCAs judgment on 26 July 2010, the presiding justices determined Justice Rip had erred in his interpretation of the phrase reasonable in the circumstances in subsection 69(2) and that all relevant circumstances which an arms-length purchaser would have had to consider must be taken into account. The FCAs approach differed from that of the TCC by employing a reasonable business person test to determine whether an arms length party in Glaxo Canadas position would have been willing to pay the same price Glaxo Canada paid to Adechsa. The FCA allowed the appeal and sent the matter back to the TCC for reconsideration based on assessing what an arms length distributor of Zantac would have been willing to pay, rather than what a generic arms length distributor of ranitidine drugs would have been willing to pay.

Supreme court of Canada (SCC) hearing

The crown continued to take the position that the only relevant issue was whether the pricing of ranitidine was at arms length and reiterated that no other circumstances should be considered. The crown argued that subsection 69(2) of the Act, and more specifically the statement reasonable in the circumstances, precluded the notion of asking whether a distributor could sell Zantac if it purchased ranitidine from a generic manufacturer.

While a number of the justices questioned the parties regarding the facts and circumstances, hypotheticals, implications of tax-planning strategies, and possible legislative interpretations, it is worth noting that the bulk of the questioning seemed to be driving at which circumstances should be rightly considered in determining the reasonable amount under subsection 69(2).

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Issues

According to our observations, the primary issues of interest to the SCC justices, and thus the most likely points to be addressed in the forthcoming decision, could be stated as follows: 1. What is the correct interpretation of reasonable in these circumstances? Should it take into consideration all relevant circumstances surrounding the transaction? Specifically in the Glaxo case, should consideration be given to the fact Glaxo Canada purchased ranitidine for the purpose of marketing and selling Zantac (a branded pharmaceutical) rather than selling a generic drug? 2. The interpretation of paragraph 1.42-1.44 of the 1995 OECD guidelines. For transactions that are closely connected, when is it reasonable for the transactions to be evaluated as a package and when is it reasonable for the transactions to be evaluated separately?

Specifically, for the sale of goods, when is it reasonable for product pricing to include certain services and intellectual property? 3. Is the arms length principle satisfied by packaged transactions that would have been agreed to by unrelated parties, or might the Canada revenue agency retain the power to reassess specific terms of such agreements where it deems them (when viewed on their own) to not conform to the arms length principle? These questions require some clarification, and multinational enterprises with Canadian operations, as well as Canadian transfer pricing practitioners, have reason to be optimistic that the SCCs forthcoming decision will provide some level of guidance and clarity to these challenging issues.

The full article, which includes a more detailed discussion of the TCC decision, FCA decision and the SCC hearing is available to download from www.grantthornton.ca/insights/articles
Michael Peggs Grant Thornton Canada E michael.peggs@ca.gt.com

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China

Standardising and streamlining transfer pricing investigation processes

The China State Administration of Taxation (SAT) will issue two internal circulars, named the Internal Working Procedure (Trial) of Special Taxation Adjustment and Joint Assessment Procedure (Trial) for Key Cases of Special Taxation Adjustment. These two circulars aim to standardise and streamline the transfer pricing investigation processes adopted by the tax authorities across the country. As background, China has been viewed as one of the most aggressive tax regimes in the Asia Pacific region when it comes to transfer pricing assessment, and this trend is unlikely to change in the near future. In 2011, each transfer pricing investigation case by the SAT ended up with an average assessment amount of 15 million Renminbi (RMB) (approximately 2.5 million US Dollars (USD)).

As time progresses, Chinese tax officials are also becoming more sophisticated in the transfer pricing arena, exploring new frontiers such as intangible licensing, equity transfer, thin capitalisation and location saving, to name just a few.
Rose Zhou Grant Thornton China E rose.zhou@cn.gt.com

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India

1. Update on safe harbours

During the past months, there has been significant movement on safe harbours, with the last meeting of the Safe Harbour Executive Committee convened on 29 July 2010. Included below are some high level recommendations that the committee has received from industry associations and consultants: only limit the benefit of safe harbours in respect of non-integral or economically insignificant activities prescribe a threshold limit for availing the benefit of a safe harbour deny the benefit of safe harbours in cases where internal comparables are available limit the misuse of safe harbours by setting out scrutiny norms, based on a randomised selection of cases.

Our recommendation at this stage would be for taxpayers to adopt a wait and see policy. The norms that will ultimately be prescribed could be very different and may in most probability be accompanied by stringent compliance measures.

2. Update on the Dispute Resolution Panel (DRP) proceedings for the annual year (AY) 2006-07 and AY 2007-08

The DRPs across the country have provided their instructions to the Assessing Officer (AO), in most of the cases for AY 2006-07 and before. For AY 2007-08, the Transfer Pricing Officers (TPOs) have released their orders which shall be incorporated by the AOs in their draft orders to be issued to the taxpayers. The time limit for AOs to complete this process for AY 2007-08 was 31 December 2010. Although in the majority of cases the orders of the TPOs have been upheld, contrary to the general apprehension, the DRPs have also actually ruled in favour of the assessees.

In a recent Mumbai conference discussion, it was commented that based on first year experiences, the Department of Revenue is looking at internally making some changes in the DRP mechanism to help the taxpayer achieve its objective of minimising conflicts. The discussion also revealed that in approximately 24% of the cases, relief was given under the DRP option. Also in a few recent income tax appellate tribunal decisions the cases were referred back to the DRP for their decisions.

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3. TPOs Information technology (IT) Information technology enabled services (ITES) benchmark sets for AY 2007-08

TPOs are in the process of working out their comparable sets for the IT-ITES industry segments for AY 2007-08. They have firmed up their mark-ups for the IT segment at about 25-26% and for the ITES segment at about 33%. As in the past, the TPOs in a few locations are proactively allowing the taxpayers to adjust the comparable mark-up for differences in the working capital employed by the taxpayer as compared to the comparables.

Normally, captive IT-ITES companies in India work on advances and this always has the effect of reducing the mean mark-up expected by the TPOs. TPOs in some other locations are granting working capital adjustments if these are claimed by the taxpayer. As with past audits, TPOs have not granted any relief on account of the differences in the risk profiles of the captives compared to the risk-bearing entrepreneurial companies selected in the benchmark set.
Karishma Phatarphekar Grant Thornton India E karishma.rp@in.gt.com

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Italy

Domestic transfer pricing documentation

A new measure from the revenue agency director has incentivised Italian companies involved in cross-border transactions to prepare adequate transfer pricing documentation, thus complying with the OECD guidelines and the EU code of conduct recommendations. If the above companies indicate in their annual tax return (2011 being the first year of application) that they have transfer pricing documentation compliant with the structure and content provided by the above measure, they can benefit from a penalty exemption in the case of a tax audit on transfer pricing issues. This provision is particularly relevant since current penalties may vary from 100% to 200% of the assessed taxable base.

As a consequence, many companies involved in cross-border transactions have currently prepared their transfer pricing documentation for past years and are preparing reports for the current year. The measure deals essentially with the correctness of the transfer pricing report content and structure. Nevertheless, tax litigation cases on the truthfulness and reliability of comparability have started. Some issues would still need some clarification (among others the lack of materiality threshold of transactions is to be analysed in the documentation).

Advanced price agreements (APAs) international rulings

The number of unilateral APAs has been growing in recent years. Current available official data (valid for the period from 2004-2009) shows 52 proposed rulings, 19 of them having been signed already. Although a few unilateral APAs have been signed in a few months, the average length of the procedure is about twenty months, due to the complexity of the issues analysed. This average length is however in line with similar cases in other EU countries. Despite new official data to be available in April 2012, local tax authorities confirmed unofficially that the total number of proposed rulings has grown further to approximately 70 at the end of 2011. The most significant news is not only the increased number of APAs, but also that the Italian tax authorities have started to negotiate bilateral APAs, with eight cases already registered.

The Italian tax administration started to negotiate bilateral APAs within the framework of the mutual agreement procedure provided by Article 25 of the OECD Model Tax Convention. Differently from unilateral APAs, there is no domestic law regulating this procedure. The introduction of the transfer pricing documentation with a penalty protection system and the APA procedures with the extension to bilateral APAs will enhance the relationship between taxpayers and the tax administration, based on a transparent and proactive approach. Furthermore, in recent years the Italian tax authorities have increased their cooperative attitude with other EU and non-EU tax administrations.

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Criminal relevance of tax avoidance behaviour connected to business restructuring

The criminal relevance of certain business restructuring operations suspected to have a tax avoidance purpose is one of the most important issues arising from a recent domestic case law. In this respect, a new decision by the Italian supreme court deals with the case of a pan-EU business restructuring implying the transfer of assets and functions outside the national territory. The court argued that the whole transaction was performed essentially for tax avoidance purposes. In particular, although an exit tax consideration had been paid, the tax authorities disregarded the business soundness of the operation and also assessed a different arms length value of the asset transferred.

The general principle set out by the court is that tax avoidance behaviours set out by a taxpayer (among them, a missing or untruthful tax return) are likely to be subject to criminal sanctions in addition to the administrative sanctions usually applied. The basis for this is that it is possible for the taxpayer to obtain an advance ruling from the tax authorities, and if the taxpayer does not make a request then they might be charged with criminal sanctions in the case of a tax audit.
Paolo Besio Grant Thornton Bernoni & Partners E paolo.besio@gtbernoni.it

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Japan

Japans response to the 2010 revisions to the OECD transfer pricing guidelines for multinational enterprises and tax administrations

Japan has adopted a most appropriate method rule that is effective for fiscal years starting on or after 1 October 2011. To date, the three traditional transaction-based methods comparable uncontrolled price, resale price, and cost plus have been the preferred methods of the national tax agency and have had preference in Japans transfer pricing regulations.

The reforms which are effective from 2011 expressly allow for the application of three types of profit split methods comparable, residual, and a contribution approach whereby the arms length price is determined according to the value of the contribution made by each taxpayer to the combined operating profit or loss. To date this has been included in the special taxation measures law circular. In addition, the concept of a range of acceptable arms length prices has been adopted in the reforms. The price would then be acceptable if it fell within the stated and appropriate arms length range. Current rules do not expressly allow for a range of arms length prices.
Toshiya Kimura Grant Thornton Japan E toshiya.kimura@jp.gt.com

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Mexico

Risk profiles

In Mexico, the Tax Administration Service (SAT) is in the process of creating a taxpayers risk profile, in order to identify those taxpayers who are not properly complying with their tax obligations or are implementing aggressive tax strategies. This has allowed the SAT to focus their auditing efforts on these specific taxpayers.
Transfer pricing audits

SAT is in the process of modifying the format of the informative return on related party transactions, which is intended to include more detailed information, as well as information on domestic related party transactions.
Court cases related to transfer pricing

In the case of transfer pricing audits, the SAT has focused on business restructurings, service transactions, and the pharmaceutical and hotel industries. When the recipient of the service is a Mexican taxpayer, it must be verified that the service is needed and that through the supporting documentation it was actually provided; the taxpayer must then prove to be compliant with the arms length principle.

As audit activity increases, the court activity also increases. There have been some new resolutions from the tax court, as detailed below. One of these resolutions is in connection with a distributor who acquired products from a related party abroad. In its transfer pricing study, the taxpayer analysed this transaction using the resale price margin (RPM) and it concluded that the transaction was carried out at arms length.

As a result of an audit performed by the SAT, they concluded that the RPM was the appropriate method and also included three additional comparable companies to the analysis. In the replying documentation, the taxpayer included the additional comparable companies and also used the transactional net margin method as a sanity check or secondary method. In the analysis, the company performed the following adjustments: Accounts receivable, inventories and a unique adjustment due to operating expenses intensity. It also considered three fiscal years for its financial data versus the three years of financial information from the comparable companies.

The final statement from the SAT stated that the controlled transaction was not carried out at arms length, arguing that the adjustment due to operating expenses intensity was not reasonable. Finally, the SAT claimed that the financial information that should be used in the analysis is the fiscal year for the tested party, compared to a three year cycle for the comparable companies. The case was filed for a trial between the taxpayer and the SAT and the court issued a favourable resolution to the taxpayer.

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The basis of the resolution was that Mexican income tax law states that reasonable adjustments should be made and that, in order to stabilise the economic cycle, the taxpayer can use its information from several years. Despite this, regulations are set in order to improve the comparability of the independent parties information and the law does not state the number of years of an economic cycle or the adjustments that should be performed. The second case is related to the import of certain active ingredients made by a pharmaceutical company. The SAT used secret comparable information and product information gathered by the Mexican customs office, which considered the price of the active ingredients imported.

According to the Mexican tax officers, this information source would only be considered when it is absolutely clear that the transactions between the related parties were not carried out at arms length. The resolution in this case was in favour of the SAT.
Ricardo Suarez Grant Thornton Mexico E ricardo.suarez@mx.gt.com

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Netherlands

Transfer pricing developments: Permanent establishment decree

1. Non-arms length loan

A new decree was introduced regarding the allocation of profits to a permanent establishment (PE) on 27 January 2011. This decree endorses the conclusions of the OECD report on the attribution of profits to PEs and provides details on the Dutch position.
Court cases

There are three court cases that are significant to mention in 2011, including a landmark case with respect to nonarms length loan transactions.

In the supreme court case of 25 November 2011, the taxpayer claimed a deduction of a non-recoverable loan in its tax return taking into account the borrowers negative financial situation. The supreme court considered the amount as non-deductible since the tax payer assumed the credit risk under non-arms length conditions and circumstances. No third party would have accepted such a credit risk under the same facts and circumstances. Therefore, the supreme court ruled that the loan was provided in a capacity of a shareholder not as a creditor. Furthermore, the court ruled that the interest rate for a non-arms length loan can be based on what the borrower would need to pay to a third party for such a loan with a guarantee under the same conditions.

This case has a large impact on the structuring of financial transactions by determining under what circumstances loans can be regarded as non-arms length. It may also give some planning opportunities.
2. Correction of transfer prices

3. Correction of reinsurance profit (captive case)

In the court of Breda case dated 9 February 2011, a large breeding company in its appeal to a preliminary tax assessment, recalculated the transfer prices used in its transactions with its related party. The court later ruled that the recalculation would not occur at arms length and therefore there were no grounds for lowering the Dutch companys taxable income. This court case illustrates the importance of having solid transfer pricing documentation. When a company prepares solid transfer pricing documentation, the burden of proof with respect to the arms length nature of transfer prices remains with the Dutch tax authorities.

In the court of the Hague case of 7 July 2011, the taxpayer is engaged in operating bungalow parks and providing related services including the provision of insurances. The tax inspector increased the taxable profit in the Netherlands by disregarding the activities of its captive insurance related company in Ireland. The court did not agree with the tax inspector in its position and ruled that the taxpayer had a business reason to restructure and establish a captive insurance company in Ireland. This is the first such case since the Dutch tax authorities restarted actively auditing captive insurance structures.
Michiel van den Berg Grant Thornton Netherlands E michiel.vanden.berg@gt.nl

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Poland

Poland is one of the few European countries where transfer pricing documentation is not required (but in practice there are some doubts about it) to prove the correctness of prices. Conducting an analysis of whether the pricing of a transaction is at market level is not an obligatory part of the tax documentation. In 2010, a project to change the rules on transfer pricing documentation and the clarification of this issue was proposed. The draft guidelines included a proposal for the tax documentation to present the comparable market data justifying that arms length conditions applied in the transaction. However, the project was abandoned in the course of further legislative work. We can expect a return of the concept in the future.

The increasing number of tax audits

Tax control offices examine issues related to transfer pricing. This is a consequence of the minister of finances annual instructions. Since 2010, the minister of finance imposed a special emphasis on transfer pricing documentation with related parties. This year will largely be a continuation of these activities. Inspections by the tax authorities are not limited to formal assessments of the correct transfer pricing documentation preparation but more often are aimed at the verification of whether the conditions between related party transactions are in line with the arms length principle. The Polish tax authorities have begun creating special departments dedicated to transfer pricing related issues. Over the past three years, penalties of approximately 140 million Polish zloty (PLN) increased the amount of income taxes additionally

levied by the tax authorities for companies contravening transfer pricing rules and in transactions between related parties.
Advance pricing agreements (APA)

The Polish minister of finance may issue a decision as to whether he finds a given method of determining the transfer price between related parties acceptable. Under the law, the decision will be binding upon the tax authorities in the case of other tax procedures (such as tax audits and tax-legal proceedings). The ministry of finance imposes a charge for the APA application. This is equal to a 1% value of the transaction that is subject to APA application (minimum 5,000 PLN, maximum 200,000 PLN). Entities who decide to draw up an APA have to prepare documentation containing detailed information about realised transactions, especially the method used to calculate transaction values and information

about all the costs connected with the transaction. Entities will bear the additional cost of professional consultants who have the know how to prepare the appropriate documents. Recent statistics on APAs show very little interest in this form of risk elimination in Poland. Since 2006, the ministry of finance has issued just 26 decisions in this regard (up to 10 October 2011). Taxpayers rarely decide to conclude an APA because of the long duration (average 19 months) and high cost of proceedings.
Agnieszka Staniszewska Grant Thornton Poland E agnieszka.staniszewska@pl.gt.com

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Russia

New rules 2012

Transfer pricing is becoming a hot topic in Russia these days. Although the current legislation contains relevant provisions, they have not worked efficiently since their implementation in 1999. However, new Federal Law (#227FZ) of 18 July 2011 (the Law) enacted comprehensive transfer pricing rules coming into force starting 1 January 2012. According to the Law, companies that fall under the scope of transfer pricing rules will be obligated to disclose related party transactions and provide tax authorities with a transfer pricing study documenting the intercompany prices used. This article gives companies a general overview of the new transfer pricing rules effective from 2012, enabling companies to identify if they are subject to them.

If your business is likely to be affected by the new rules we will be happy to assist you in developing an action plan and a transfer pricing policy in order to be compliant with the new legislation.
Key changes

Similarly, courts will have the right to declare the parties as related if the relationship between them may have an impact on the conditions and outcome of the transaction performed by these parties or the results of their economic activity.
Controlled transactions

transactions with companies

incorporated or residing in offshore jurisdictions (including non-related

The ownership ratio necessary to declare parties related has increased from 2025%. The new rules provide for being related through participation via a chain of ownership of more than 50% each. Starting in 2012 sister companies are also within the scope. Companies can also be treated as related parties due to control on the board of directors, provided that: more than 50% of the directors of these companies are the same individuals not less than 50% of the directors are appointed/ chosen by the same individual.

The Law provides for the following list of controlled transactions: related parties cross-border transactions (no volume threshold is defined). foreign trade transactions with commodities that have a total income exceeding 60 million Russian Rubles (RUR)(approximately two million USD) per calendar year.

parties). This list established by the Russian Ministry of Finance includes territories with beneficial tax regimes and non-transparent fiscal bodies. A threshold of 60 million RUR per calendar year has been established for such transactions. transactions between related parties carried out via unrelated intermediary companies, provided such companies do not perform any additional functions, assume any risks or employ any assets.

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domestic transactions between

related parties will be subject to control in the following three cases:

1. If the amount of such transactions exceeds three billion RUR (approximately 105 million USD) in 2012, two billion RUR (approximately 70 million USD) in 2013 or one billion RUR (approximately 35 million USD) from 2014. Transactions between profitable Russian companies registered in the same administrative region are exempt from transfer pricing control, provided they do not have any subdivisions in other administrative regions within Russia or abroad.

2. Certain types of transactions that qualify for at least one of the following conditions and where the aggregate income exceeds 60 million RUR per calendar year (approximately two million USD): if one party to a transaction is subject to the mineral extraction tax and the goods are subject to the above tax at a percentage rate if one party to a transaction is exempt from profits tax or applies a 0% tax rate, while the other party is a profits tax taxpayer in Russia and does not apply a 0% tax rate if one party to a transaction is resident in a special economic zone, while the other is not resident in that special economic zone (effective from 1 January 2014).

3. Transactions where one party applies the unified agricultural tax or a unified imputed income tax, while the other party pays tax under the general rules. This type of transaction is recognised as controlled starting from 1 January 2014 if the aggregate income exceeds 100 million RUR per calendar year (approximately 3.5 million USD).
Transfer pricing methods

The CUP method is named as a preferred method. However, if it is not applicable a company may use the most appropriate method. If the above mentioned methods do not accurately define the price of an individual transaction it can be determined through an independent valuation.

The Law sets five methods for determining the transaction price: 1. Comparable uncontrolled price (CUP) method 2. Resale price method 3. Cost plus method 4. Transactional net margin method 5. Profit split method.

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Sources of data

Transfer pricing reporting

The Law provides a list of information sources that can be used to determine prices of comparable transactions and margin levels. According to the Law comparables from the Russian financial statements should be used. Foreign comparables are applicable only if Russian ones do not exist. Thus, even if the group of companies has a global or regional transfer pricing study based on foreign comparables, it might be necessary to carry out benchmarking using Russian comparables.

According to the Law, companies will have to notify the tax authorities of the controlled transactions that occurred during the previous year by 20 May. These notifications shall be limited in scope, such as subject, parties and total amount of the transaction.
Transfer pricing documentation terms

The transitional period allows companies with controlled transactions under 100 million RUR (approximately 3.5 million USD) for the year 2012 and 80 million RUR (approximately 2.8 million USD) for the year 2013 to enjoy an exemption from filing notification and preparing transfer pricing documentation. However, starting in 2014, the thresholds will be abolished.
Transfer pricing documentation content

information on each parties functions (if a functional analysis is carried out by the taxpayer), assets employed (related to the controlled transaction) and commercial risks. If a taxpayer uses methods established by the tax code, the following information should also be provided: the grounds for the choice and applicability of the method used the sources of data calculation of the market prices interval (profitability interval) used for the benchmarking the grounds for the choice and applicability of comparables information about other facts, which had influence on the controlled transaction price (margin) etc.

Transfer pricing documentation supporting the arms length nature of prices applied and the method used may be requested by tax authorities not earlier than 1 June of the year following the calendar year when the controlled transactions took place. Once it is requested the company has 30 days to present transfer pricing documentation for the tax authoritys review.

The documentation shall include the following information: description of the controlled transaction, its parties and conditions, including the description of the pricing method (if any) and other information on the transaction

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Advance pricing agreements

Transfer pricing audits

Transfer pricing penalties

Mirror adjustments

Taxpayers may be entitled to apply for an APA. However, this is only possible for Russian companies registered as the largest taxpayers. To conclude an APA a taxpayer should prepare an application with a description of methods, sources of information, etc. and pay a state duty of 1.5 million RUR (approximately 50,000 USD). APAs protect the company from potential tax assessments, penalties and late payment interest.

Transfer prices will be audited by the tax authorities in the course of a separate transfer pricing audit with certain transitional provisions prescribed by the Law. In particular, an audit for the year 2012 may only be initiated before 31 December 2013, while a 2013 audit may only be initiated before 31 December 2015. After the above provisions expire, a transfer pricing audit may cover three years preceding the year when the audit is initiated.

The Law exempts any transactions that occur during the years 2012 and 2013 from transfer pricing penalties. A penalty of 20% will apply to transactions occurring during the period 2014-2016. Starting from 1 January 2017, a 40% penalty will be imposed in cases where a transfer pricing adjustment was applied. The submission of transfer pricing documentation protects a taxpayer from penalties even if an adjustment is made. In contrast to APAs no exemption is established in relation to the amount of tax assessment and late payment interest.

In cases where tax authorities have made a tax assessment for one party of the transaction, the other party has the right to mirror the adjustment. This adjustment can only be made after the tax assessment is settled. Mirror adjustments are only allowed in respect to transactions within the Russian Federation.
Nadya Zubkova Grant Thornton Russia E nadya.zubkova@ru.gt.com

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South Africa

Recent South African developments

Section 31 of the Income Tax Act No.58 of 1962 (the Act) contains the main legislative provisions relating to transfer pricing. The South African transfer pricing rules essentially require that an arms length/market related price be paid/charged in respect of the crossborder supply of goods or services between connected persons. Should the commissioner for the South African revenue service (SARS) be of the opinion that an arms length price has not been paid or charged, he is entitled to adjust the consideration for the transaction in order for it to reflect an arms length price, resulting in a potentially higher tax liability for the taxpayer.

The old section 31 has recently been substituted with a new section 31 in terms of the Taxation Laws Amendment Act No. 7 of 2010. This change was implemented due to the wording of the old section causing structural problems and uncertainty as it placed excessive emphasis on isolated transactions rather than overall arrangements. Undue emphasis was also placed on the comparable uncontrolled price method rather than other more practical transfer pricing methodologies. In addition, SARS was of the opinion that the wording should focus on profits rather than price as this is more consistent with the wording of the double tax treaties concluded by South Africa.

The new wording focuses on the economic substance of transactions and is more in line with the OECD guidelines. The new section will essentially apply to any transaction, operation, scheme, agreement or understanding directly or indirectly entered into between cross-border connected parties where: any term or condition of that transaction, operation, scheme, agreement or understanding that deviated from any term or condition that would have existed between those parties dealing at arms-length the transaction, operation, scheme, agreement or understanding results or will result in a tax benefit being derived by either party.

There has also been major discussion surrounding the thin capitalisation rules and whether the 3:1 debt equity ratio safe-harbour applied in the case of financial assistance has in effect fallen away. The safe harbour is contained in a separate practice note and it is not clear whether this has in fact been withdrawn by SARS. This amendment would result in taxpayers being required to establish what amounts they would have been able to borrow in the open market, on what terms and conditions and at what rate. This has stirred debate as to whether or not the amendment is plausible and thus, SARS is to issue guidance in this respect. In line with most countries, SARS has acknowledged transfer pricing as a main income source and focus has been placed on this area with audits now being conducted across all industries by the transfer pricing unit, a specialist unit at the large business centre in Johannesburg.
AJ Jansen van Nieuwenhuizen Grant Thornton South Africa E aj@gt.co.za
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Spain

Spainish supreme court decision: Swiss principal has Spanish permanent establishment through its subsidiary in Spain

Roche Vitamins is the Spanish subsidiary of Roche Vitamins Europe (based in Switzerland), that restructured its business in 1999. The subsidiary previoulsy performed the functions of manufacturing, importing and distributing goods, as a full risk entrepreneur. After the restructuring, the subsidiary concluded two contracts with its related party Roche Vitamins Europe. The Spanish subsidiary became a contract manufacturer and sales agent, whose profits were considerably lower than those received by a full risk entrepreneur.

It should be noted that the subsidiary had no capacity to contract or negotiate for the parent company, and the products were sold and the prices were fixed by the Swiss company. The progression through the courts has taken more than nine years, and the recent ruling by the Spanish supreme court on 12 January supports the tax authorities position and the national high court in that the Spanish company is a dependent agent of the Swiss principal. The national high court argued that the dependent agent clause in the SwissSpanish treaty was to be interpreted broadly and applied not only to situations where the agent has authority to conclude agreements on behalf of the principal, but also when, in the nature of its activity, an entity has involvement in the business activities at the national level.

Although the subsidiary had no capacity to contract or negotiate for the parent company, this did not prevent the application of the dependent agency clause in the Swiss-Spanish tax treaty. The agency contract obligated the subsidiary to promote the goods sold by the parent, which the court felt constituted a greater involvement in the Spanish market and showed that the subsidiary did not only process purchase orders issued by its parent. So finally, it was held that the subsidiary company constituted a permanent establishment based on article 5.1 of the tax treaty and article 5.4 because all the activity of the subsidiary was directed, organised and managed by its parent, and therefore assumed more risks with the economic activity in Spain.

Another important issue that the supreme court considered was that the Spanish entity had only one client (the Swiss company), and that the manufacturing prices were merely a refund of cost which is not truly a market price. As a result the profits derived from manufacturing and distribution have been attributed to the permanent establishment in Spain. The ruling goes against the French Zimmer case and the Norwegian Dell Case with the interpretation of article 5.4 of the dependent agency clause of the tax treaty, because it did not focus on the literal meaning of the clause, that the agent has the authority to conclude binding contracts for the parent.
Gabriel Yakimovsky Grant Thornton Spain E gabriel.yakimovsky@es.gt.com

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United Kingdom

Controlled Foreign Companies (CFCs)

Branch exemption

Patent box

Thin capitalisation

Draft legislation has been released introducing new rules for CFCs. The new measures are intended to more accurately target artificially diverted UK profits and keep the compliance burden to a minimum, although it is debatable how far this objective has been achieved. In some cases (e.g. where the management and control of the CFCs and assets are entirely outside the UK) there will be no CFC change. In other cases it will be necessary to consider whether any significant people functions (SPFs as described in the OECD report on attribution of profits to a permanent establishment) are based within the UK. The final CFC legislation is being published as part of the Finance Bill 2012.

A company has been able to elect the profits of its foreign permanent establishments to be exempt from UK corporation tax since March 2011. Conversely any losses made by the PE will not attract relief in the UK. As the election is irrevocable, and applies to all existing and future permanent establishments of the company, the decision to make an election is not one to be taken lightly. Where the UK has a full treaty in place with the permanent establishment jurisdiction, the attribution is to be made in accordance with that treaty. If there is no full treaty in place, the exempt profits are those that would be attributed to the permanent establishment if an OECD treaty was in place. In addition, a number of exclusions are provided and an anti-diversion rule applies.

The introduction of this new regime will apply a 10% corporate tax rate for all profits attributable to qualifying intellectual property (IP) from 1 April 2013. Qualifying IP includes patents granted within the UK and European patent offices. The UK regime goes further than many countries in allowing profit from products which include a patented item and from patented processes. It is intended to encourage companies to locate high-value jobs and activities associated with the development, manufacture and exploitation of patents in the UK. The patent box will apply to existing as well as new IP, and to acquired IP provided that the group has further developed it. This should potentially benefit a wide range of companies which receive patent royalties, sell patented products, or use patented processes as part of their business.

Advanced thin capitalisation agreements (ATCAs) are formal binding agreements under the APA legislation and the process is designed to help resolve financial transfer pricing issues which have a significant commercial impact on an enterprises results, where the issues would be unlikely to be regarded as low risk by Her Majestys Revenue and Customs (HMRC), or where the arms length provision is a matter of doubt. The biggest advantage of having an ATCA in place is the high level of certainty that it provides. The ATCA process represents a pro-active way of managing UK tax exposures on UK connected party debt. A new draft ATCA has been published as part of a new statement of practice (SOP). This replacement updates the legislative references and reflects HMRCs current practice.

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The SOP includes a model ATCA to ensure greater consistency between agreements and hopefully shorten the period of time it takes to reach an agreement. HMRCs recent statistics indicate the median time to reach an ATCA agreement once submitted is currently around seven months, i.e. 50% are agreed within seven months.

More transfer pricing statistics

Delays in the resolution of transfer pricing issues have in the past been a major concern to large business customers, but HMRC has been seeking to improve this. For the year 2010/11 the median time to resolve transfer pricing enquires was just over 12 months and 50% of APAs are agreed within 14 months. For Mutual Agreement procedures the median time to resolve cases is 19 months.
Wendy Nicholls Grant Thornton UK E wendy.nicholls@uk.gt.com

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Whos who Contributors

Fernando Fucci Grant Thornton Argentina E fernando.fucci@ar.gt.com Jason Casas Grant Thornton Australia E jason.casas@au.gt.com Michael Peggs Grant Thornton Canada E michael.peggs@ca.gt.com Rose Zhou Grant Thornton China E rose.zhou@cn.gt.com Karishma Phatarphekar Grant Thornton India E karishma.rp@in.gt.com Paolo Besio Grant Thornton Bernoni & Partners E paolo.besio@gtbernoni.it Toshiya Kimura Grant Thornton Japan E toshiya.kimura@jp.gt.com Ricardo Suarez Grant Thornton Mexico E ricardo.suarez@mx.gt.com Michiel van den Berg Grant Thornton Netherlands E michiel.vanden.berg@gt.nl Agnieszka Staniszewska Grant Thornton Poland E agnieszka.staniszewska@pl.gt.com Nadya Zubkova Grant Thornton Russia E nadya.zubkova@ru.gt.com AJ Jansen van Nieuwenhuizen Grant Thornton South Africa E aj@gt.co.za Gabriel Yakimovsky Grant Thornton Spain E gabriel.yakimovsky@es.gt.com Wendy Nicholls Grant Thornton UK E wendy.nicholls@uk.gt.com
2012 Grant Thornton International Ltd. All rights reserved. This information has been provided by member firms within Grant Thornton International Ltd, and is for informational purposes only. Neither the respective member firm nor Grant Thornton International Ltd can guarantee the accuracy, timeliness or completeness of the data contained herein. As such, you should not act on the information without first seeking professional tax advice. Grant Thornton International Ltd (Grant Thornton International) and the member firms are not a worldwide partnership. Services are delivered independently by the member firms.

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