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August 4, 2016

Transfer Pricing Quarterly Update: Second Quarter 2016 (article)

Countries continue to develop systems and issue guidance implementing the OECD’s Base Erosion and Profit Shifting (BEPS) recommendations. In this quarterly transfer pricing update, we discuss Australia’s recent guidance about its local file design. We also review a recent taxpayer victory in a transfer pricing court case and some additional guidance from the OECD.

Australia Country-by-Country Reporting Update

The Australian Tax Office (ATO) has released guidance on the design of the local file to comply with Australia Country-by-Country (CbC) reporting requirements.

First, the guidance outlines the two tiers of the local file, with the amount of information required for a particular local file tier reflecting the entity’s business operations, complexity and perceived level of risk. The ATO guidance references a short form exceptions list and an exclusions list. The short form exceptions list details specific types of transactions, which if engaged in by the Reporting Entity, will mean that it will not be eligible to complete the short form local file. The exclusions list is only relevant for those entities completing a local file, and identifies transactions that are not material controlled transactions for the purposes of Part B of the local file.

Next, the guidance discusses the content to be included in the two tiers of the local file. The short form local file requirements include the following information about the Reporting Entity:

  • Description and copy of the organizational structure of the Reporting Entity, including a description of the individuals to whom local management reports and the countries in which such individuals maintain their principal offices;
  • Description of the Reporting Entity’s business and strategy;
  • Description of any business restructuring affecting the Reporting Entity in the current or previous income year, and an explanation of its significance;
  • Description of any transfers of intangibles in the current or previous income year, and an explanation of its significance; and
  • Llist of key competitors of the Reporting Entity.

The full local file consists of the information in the short form local file as well as additional requirements in two parts. Part A requirements contain details of the controlled transactions, including the following information:

  • Name of the Australian counterparty;
  • Name of the non-resident counterparty;
  • Country of tax residency of the non-resident counterparty;
  • Category of the transaction per Table 4;
  • Amounts of consideration payable/receivable (of a capital nature for Australian income tax purposes);
  • Amounts of expenditure/revenue (not of a capital nature for Australian income tax purposes);
  • For international related party (IRP) debt factoring and securitization arrangements, the book value of transferred debts;
  • Where foreign currency gains or losses are incurred for the transaction, disclosure of the FX gain/loss
    • Note: for the above labels:
      • Zero values are shown for nil payment or consideration (as per item 14a of the International Dealings Schedule [IDS])
      • There will be an indicator for non-monetary consideration (as per item 14b of the IDS)
  • The transfer pricing method relied on for the transaction per Table 3;
  • If it is a capital transaction, the capital asset pricing methodology used;
  • The transfer pricing documentation code; and
  • For the purposes of Part B, whether the transaction is covered by a category on the Exclusions List.

Part B includes information for each transaction not covered by the Exclusions List (material controlled transactions):

  • The transfer pricing method relied on for the transaction by the IRP per Table 3 (or an indication the Reporting Entity was not able to obtain the information);
  • An indication whether there is a written agreement and, if so, whether the agreement has been previously provided to the ATO (where the agreement has been previously provided, the ATO will require the title of the agreement to enable ATO identification);
  • A copy of the agreement (unless previously provided to the ATO);
    • Note: There will be special rules for providing agreements included in a Relevant Agreement Series or under an Umbrella Agreement
  • Any foreign advance pricing arrangements (APAs) or rulings provided by another jurisdiction in relation to an agreement (unless previously provided to the ATO).

Medtronic Wins Transfer Pricing Dispute

Medtronic received a favorable ruling from the U.S. Tax Court in its transfer pricing dispute with the IRS. The IRS argued that Medtronic U.S. should have received higher royalty rates from its Puerto Rico based subsidiary, MPROC. The IRS argued that MPROC was a manufacturer and should have earned profit similar to that of routine medical device manufacturers according to the benchmark range established using the comparable profits method (CPM). Had the IRS won the case, Medtronic would have owed nearly $1.4 billion for the years 2005 and 2006.

The IRS contended that Medtronic's uncontrolled license arrangements were not comparable to the Medtronic U.S. and MPROC royalty agreement and argued that the CPM was the best method to determine arm's length royalty rates rather than the comparable uncontrolled transactions (CUT) method. They also argued that Medtronic performed all but one economically significant function; product assembly performed by MPROC, with Medtronic U.S. providing significant oversight and help. The IRS argued that the royalty rate MPROC paid on sales should be 49.4 percent in 2005 and 58.9 percent in 2006.

Medtronic argued that the originally agreed upon royalty rates of 44 percent for devices and 22 percent for leads were greater than arm's-length. Using the CUT method, Medtronic concluded that a 29 percent royalty for devices and 15 percent royalty for leads were arm's-length. Medtronic argued that the IRS did not adequately consider that product quality determines success in the implantable medical device industry and that MPROC is ultimately responsible as the manufacturer of these devices.

The Tax Court agreed with Medtronic that MPROC provided more than just product assembly. They said that MPROC played a more important role because of the importance of quality in the medical device industry, held a valuable intangible in its license rights, and that MPROC bore risk related to the manufacturing of the medical devices. The Tax Court did, however, increase the royalties charged by Medtronic U.S. to Medtronic Puerto Rico from 29 percent to 44 percent for devices and 15 percent to 22 percent for leads. These rates were similar to the rates agreed upon between the IRS and Medtronic within a prior memo of understanding.

OECD New Guidance on the Implementation of Country-by-Country Reporting

On June 29, 2016, the OECD BEPS Project released new guidance on the implementation of Country-by-Country (CbC) reporting. This guidance covers the following issues:

  • Transitional filing options for MNEs (“parent surrogate filing”),
  • The application of CbC reporting to investment funds,
  • The application of CbC reporting to partnerships, and
  • The impact of currency fluctuations on the agreed EUR 750 million filing threshold.

In addition, the OECD will provide information on country specific aspects of CbC implementation, including the effective dates of CbC legal frameworks, local filing and surrogate filing mechanisms and identifying the agreements for exchange of CbC reports that are in effect. Given that CbC reporting is one of the BEPS minimum standards, a peer review of the implementation of CbC reporting will be conducted to ensure that the implementation of jurisdictions' domestic legal frameworks is timely and in accordance with the Action 13 Report.

Please contact us with any questions on how these developments may impact your company.

Copyright © 2016, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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