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Global Transfer Pricing Studie EY 2011

Introduction

Transfer pricing remains a key tax challenge for the world’s leading companies. That’s the major observation from our latest Ernst & Young survey of tax directors and international tax practitioners.

And with good reason. Faced with a slowly recovering global economy and record deficits, governments are increasingly focused on raising revenues through taxation. As a result, more and more jurisdictions are ramping up their enforcement efforts — not only

in developed nations but also in many emerging markets such as China, India, Russia

and Brazil.

At the same time, the Organisation for Economic Co-operation and Development (OECD), whose work largely defines the transfer pricing rules adopted by member nations, continues to refine and update its transfer pricing guidelines. In 2010, among other initiatives, the OECD issued a thorough update of its guidance on comparability and profit methods.

For 2011, the OECD is shifting its transfer pricing focus to better defining the issues surrounding intangibles such as trademarks, patents and even business models. The OECD will be issuing guidance, hopefully within the next few months, that will form the basis of many governments’ attitudes in dealing with these difficult subjects.

This year also saw the publication of the OECD’s new chapter on business restructurings and its new report on the attribution of profits to permanent establishments. Most global businesses, in the face of mounting pressure to improve profitability, have been undertaking some form of cost reduction or business change program. In many cases, this process includes substantial changes to everything from strategic planning to supply chain. Each and every business change brings with it transfer pricing implications.

Since 1995, Ernst & Young has surveyed multinational enterprises (MNEs) on international tax matters with special emphasis on what continues to be a leading international tax issue — transfer pricing. The ever-increasing scope of our transfer pricing research reflects the growing number of countries that devote attention to transfer pricing. This is noted through increased enforcement and regulatory activity, as well as the increasing variety of transfer pricing issues facing MNEs.

For this survey, we commissioned Consensus Research International to conduct a series of independent interviews of 877 MNEs across 25 countries. The resulting report summarizes the transfer pricing practices, perceptions and audit experiences of a wide range of global corporate tax practitioners. The survey provides insights into how MNEs are dealing with the myriad of economic, regulatory and fiscal changes taking place around the world. For the first time, our survey queries MNEs on their business restructuring activities, an area in which many of our clients express keen interest.

We trust that you will find our 2010 Survey results, together with our insights and recommendations, useful and informative. In our view, there is no question that transfer pricing will remain one of the most important tax issues over the next few years and that tax authorities will continue to increase their focus in this area. Every business needs to be well-prepared for the coming challenges as enforcement efforts will undoubtedly increase significantly.

John Hobster

Head of Global Accounts Transfer Pricing Thomas Borstell Global Director Transfer Pricing Services

2010 Global Transfer Pricing Survey 1

Executive summary

Importance of transfer pricing

Transfer pricing is one of the key tax issues today — it is actually more important today than it was two years ago.

Audit experiences

Transfer pricing audits are increasing in significance, intrusiveness and scope.

Controversy management

Litigation remains infrequent — but is on the rise. Meanwhile, the use of and degree of comfort with APAs are increasing — while experience with new arbitration processes remains extremely limited.

Trends in transfer pricing issues and approaches Enforcement actions are placing greater emphasis on intercompany financing transactions and service transactions.

T axpayer approaches

Taxpayers are taking a more coordinated and globalized approach

to transfer pricing documentation.

T ax and efficient supply chain management

Tax considerations relating to business restructuring are expected to become more important in the coming years.

Addressing the challenges of globalization

2

2010 Global Transfer Pricing Survey

3

Key insights and recommendations

Previous editions of this survey have concluded that taxpayers should be adopting efficient global documentation strategies; devising dispute resolution plans, both preventative and remedial; and embedding tax considerations in business change. This edition re-emphasizes those points, but with some subtle differences:

? ?A udit trends reveal the need for “glocal” documentation. MNEs should tailor their global transfer pricing platform to local requirements in higher-risk, more complex countries.

? ?W ith audits up and material penalties significantly increased, avoiding disputes will be tougher. MNEs should consider a more proactive approach to controversy management, including appropriately targeted APAs.

? ?S ervice, intangibles and financing transactions are increasingly in the sights of tax authorities. Our experience is that documentation of these categories of transactions often lags behind documentation for tangible goods transactions. MNEs should develop or enhance their documentation for these transactions.

? ?O ECD developments are pushing profit-based methods to the forefront while MNEs continue to rely on transactional methods to determine and document their intercompany pricing policies. MNEs should consider profit-based methods as corroborating or primary methods.

Addressing the challenges of globalization

4

Key trends in global taxation and transfer pricing

The downturn in the global economy has raised the profile of transfer pricing. Tax authorities are both upgrading and increasing their staffing while at the same time placing greater demands on corporations in areas such as documentation. Meanwhile, the OECD is revising and updating key elements and provisions of its transfer pricing guidance.

As a result, companies are finding they must work harder to define and adopt a more proactive stance in defending their transfer pricing policies and practices.

Tax authorities are targeting intercompany transactions in

an attempt to protect and increase their tax bases. Since the 2007 Survey, tax authorities in key jurisdictions have taken steps such as significantly increasing their transfer pricing staffing, adopting more centralized approaches to managing transfer pricing enquiries and establishing a more strategic, risk-based approach to prioritizing transfer pricing reviews. In the United States, the Internal Revenue Service (IRS) added 1,200 employees in 2009 to deal with international issues, with another 800 added through the end of 2010. The IRS has established a goal of achieving a staff of 120 transfer pricing economists, the highest number in its history. As part of its transfer pricing focus, in December 2009 the IRS announced a number of important changes. These include:

? The creation of a Transfer Pricing Practice.

? The establishment of a Transfer Pricing Council to coordinate transfer pricing reviews.

? The establishment of a tiered approach to targeting intercompany transactions based on their potential

for abuse. Transfer pricing has also assumed greater public prominence in the United States as a result of articles in the popular press and Congressional hearings on tax avoidance through “abusive” transfer pricing.

In the United Kingdom, Her Majesty’s Revenue and Customs (HMRC) has made a similar, coordinated transfer pricing push. In June 2008, HMRC issued its Guidelines for the Conduct of Transfer Pricing Enquiries, which included the creation of a specialized Transfer Pricing Group, a transfer pricing review board and a risk-based approach to transfer pricing enquiries. In late 2010, HMRC also issued guidance to its field teams on more extensive use of penalties in transfer pricing cases.

The Chinese tax authority has also adopted a targeted approach, designating 30% of Chinese taxpayers as key

audit targets based on selected criteria. The criteria include significant intercompany transactions, consecutive years without taxable income, reduced profit margins and low margins relative to industry peers. The audit initiative will rely on profit-based transfer pricing measures in preference to transactional approaches.

The increased focus on transfer pricing extends to smaller markets, as well. The Australian Taxation Office is planning significant increases in transfer pricing personnel and the launch of a strategic transfer pricing initiative focusing on business restructuring, intra-group financing, mining services and changes in profitability.

Along with increased transfer pricing staffing, tax authorities have or will have at their disposal a number

of new or proposed disclosure requirements. These requirements will increase the transparency of taxpayers’ intercompany transactions and their transfer pricing risks. In Latin America, many jurisdictions have mandated transfer pricing disclosure forms, and others have regulations that mandate the submission of transfer pricing reports

contemporaneously with the corporate tax return.

2010 Global Transfer Pricing Survey

5

More countries, more issues, more tax authority aggression, and more disputes – that’s why transfer pricing is the number one international tax issue for respondents. More countries, more issues, more tax authority aggression and more disputes — that’s why transfer pricing is a leading international tax issue for respondents.

In the United States, the IRS has also increased penalties for failure to accurately file related-party disclosure forms (Forms 5471 and 5472). It has also introduced Schedule UTP, which requires the disclosure of detailed information on uncertain tax positions, including transfer pricing positions. At the same time, the IRS is developing protocols to conduct joint audits with its treaty partners.

T ax authorities are armed with increasingly sophisticated and broad transfer pricing tools. Since the 2007 Survey, the IRS has issued final transfer pricing regulations for intercompany services and revised temporary regulations

for cost-sharing transactions. During the same period, the OECD issued revisions to Chapters I through III of the Transfer Pricing Guidelines along with a new chapter on business restructurings. The Australian tax authorities issued similar guidance on business restructurings in June 2010, and the German administration is expected to soon finalize its July 2009 draft circular on this subject. These regulatory and legislative developments are characterized by a number of common features, including:

? Greater sophistication and flexibility in the selection of transfer pricing methods, including the OECD’s move away from a hierarchy of methods

? The adoption of a “realistic alternatives” criterion into

the selection of best method in the US transfer pricing regulations and into the OECD guidelines

? A tendency to extend the scope of a transfer pricing analysis beyond a single party to examine its effect on the profit of the counterparty and/or the full value chain

? The OECD’s prohibition of inappropriate shifting of risk (and profit), which includes the use of either intercompany agreements or “low risk” transfer pricing methods, such as cost-plus arrangements, that divorce risk from the entities that control it

? Enhanced OECD comparability standards mandating more effort and rigor in the selection of benchmarks ? A trend toward macro-level examinations, such as evaluating the effect of business restructurings on the entire value chain or evaluating the aggregate return on investment under a cost-sharing arrangement

? Blurring the lines between transaction types through the recognition of so-called “high-value” services

Even as taxpayers cope with more intense and more sophisticated scrutiny in developed markets, the geographic scope of documentation requirements continues to expand. Since the 2007 Survey, China, France, Greece, Indonesia, Malaysia and Vietnam have all instituted new or significantly enhanced transfer pricing requirements. Even jurisdictions traditionally viewed as tax-favorable, such as Hong Kong and Ireland, have introduced some level of requirement for transfer pricing documentation.

The results of our 2010 Survey reflect both

the intensity and the shifting focus of transfer pricing enquiries. Taxpayers find themselves in the challenging position of documenting and defending their transfer pricing in more and more countries. The transaction types they

have to cover are increasing, and the emphasis

is changing. Controversy is on the rise as increasingly well-staffed tax authorities apply more sophisticated and sweeping transfer pricing tools. At the same time, fortunately, a wider array of dispute resolution channels is available and being used.

6

Addressing the challenges of globalization

2010 Global Transfer Pricing Survey

7This conclusion is supported by tax directors’ answers to another question. Asked how important they expect transfer pricing to be over the next two years, 32% called it “absolutely critical,” up from 29% in 2007. This suggests that the survey respondents are not complacent about their level of transfer

pricing risk.

Figure 4 summarizes the importance respondents attach to transfer pricing by industry. Tax authorities typically target industries with high-value, portable intellectual property and those that generate high margins. It is not surprising, therefore, that more respondents in the pharmaceutical

industry rank transfer pricing as their most important tax issue than in any other industry. Because pharmaceutical companies typically deploy valuable intangibles in more than one tax

jurisdiction, transfer pricing concerns typically loom large. The pharmaceutical industry has also been exposed to some of the most significant transfer pricing litigation of recent years. The technology and biotechnology industry, which is also heavily reliant on intangible property, shows the second-highest level of importance. Respondents in industries that typically have lower levels of cross-border transfers, such as transportation, telecommunications and professional services, rank transfer pricing lower among their tax concerns.

Ernst & Young’s 2010 Survey continues to demonstrate the high degree of importance tax departments assign to transfer pricing. More parent company respondents identified transfer pricing as the most important tax issue they face.

Figure 1: Most important tax issues for tax directors (parents)

Thirty percent of tax directors in parent firms worldwide identify transfer pricing as their most important tax issue. In North America, transfer pricing was paramount for 21% of respondents, but percentages were higher in other regions: 30% in Asia-Pacific (APAC) and 33% and in Europe, Middle East, India and Africa (EMEIA). The percentages were highest in

Italy (52%) and Denmark (60%). Figure 1 shows the eight other topics that registered among many respondents as the most important tax issue. Tax minimization was the only issue that rivaled transfer pricing.

Figure 2 summarizes the importance tax directors have

attached to transfer pricing over the last seven surveys. The peak of concern was in 2005 when almost 60% described it as “very important.” That percentage dropped in 2007 and 2010, but we attribute the declines to respondents’ sense that they have their transfer pricing issues under better control than they did in 2005.

Insights from the survey

T ransfer pricing still dominates

the tax agenda

Customs duties

Foreign tax credits

Cash repatriation Tax controversy Double taxation Value-added taxes Cash taxes

Tax minimization

Transfer pricing

Figure 2: Importance of transfer pricing from 1997–2010 (parents)

0%

10%20%30%40%50%60%Very important Fairly important Not very important Not at all important

30% of tax directors in parent firms worldwide identify transfer pricing as their most important tax issue.

8

Addressing the challenges of globalization There seems to be some legacy interest by tax authorities in lower-margin industries, such as the automotive and transportation industries. There is also an inconsistency between increased tax authority scrutiny of financial

transactions and the rather limited importance banks and financial institutions place on transfer pricing. We expect this perception to change in view of the increasingly sophisticated risk-assessment tools deployed by the tax authorities, which will likely expose financial transactions to more frequent review. We also expect the focus on low-margin business to

erode. By contrast, we expect much more interest in businesses with footprints in emerging markets, such as mining, oil and gas and diversified industrial products.

Figure 4: Percentage of respondents ranking transfer pricing as their most important tax issue (parents and subsidiaries)

The practice of transfer pricing is receiving greater attention

The increased importance MNEs attach to transfer pricing is driving increased deployment of both internal and external transfer pricing resources and elevating the profile of transfer pricing within the organization.

Thirty-one percent of parent respondents report some level of increase in internal transfer pricing headcount, 62% report an increase in the use of external consultants, and 23% report an increase in the use of software and other tools. Sixty-six percent indicate that they had at least one full-time equivalent working on transfer pricing, up from 55% two years ago. Forty-seven percent of parent respondents say that they have become more responsible to their boards of directors for

transfer pricing matters and 41% say they have become more responsible to their audit committees. As shown in Figure 5, ultimate responsibility for transfer pricing remains most often with the tax department (39% of respondents), followed by the chief financial officer or parent company director . Only 8% of parent respondents delegate responsibility to the local affiliate company.

Figure 5: Responsibility for transfer pricing within the organization (parents)

Parent CFO/financial director Other

Delegated responsibility to local leader

Tax department Audit committee

39%

38%

8%

3%12%

Respondents confirm ongoing interest of tax authorities in a small number of concentrated industries. This will change in the coming years.

2010 Global Transfer Pricing Survey

9As they pay closer attention to documentation, more companies are adopting a global approach.

The number of parent respondents pursuing a globally coordinated transfer pricing

documentation strategy increased from 33% in 2007 to 41% in 2010.

Despite the potential effect of the economic downturn on resources, the number of respondents that do not prepare transfer pricing documentation remains low at 3%.

Figure 8: Approach to transfer pricing documentation (parents)

Companies are paying closer attention to documentation

The heightened scrutiny of transfer pricing, the widening range of jurisdictions with documentation requirements and the

increased level of transfer pricing disclosure all increase a taxpayer’s transfer pricing risk. That increased risk is reflected in the enhanced importance survey respondents attach to transfer pricing documentation. Three-quarters of parent respondents in this year’s survey consider documentation more important now than two years ago.

Most parent respondents cite risk-based motivations for preparing documentation. Thirty-six percent identified risk mitigation as their primary motivation in preparing documentation, while the number of respondents citing audit defense as their primary motivation has more than doubled from 2007 to 20%. Fewer than 10% of respondents were motivated by either financial reporting requirements or planning considerations.

Figure 6: Top priority in preparing transfer pricing documentation (parents)

2010

2007

2010

2007

0%

10%

20%

30%

40%

50%

60%

70%

Consistent with their broader risk-based approach, respondents cite tax audit activities as the most influential factor in

determining their transfer pricing compliance (see Figure 7). This finding seems to suggest some degree of recognition by respondents of increased tax audit activity.

Respondents generally take a regional, rather than a country-specific, approach to comparables analysis. Fifty-eight percent of parent respondents indicate that they use regional samples to one degree or another , while only 38% use local comparables for all countries (see Figure 9). Perhaps reflecting the difficulty large MNEs face in assembling local comparable data for a large number of jurisdictions and transactions, the use of regional comparables was more prevalent among those respondents with revenues of $10 billion or more than among smaller

companies. With increasing tax authority aggression, MNEs will have to prepare local, as well as regional, comparables for their transfer pricing documentation.

10

Addressing the challenges of globalization As for the timing of their documentation, just over half (54%) of parent respondents indicate that they prepare documentation contemporaneously with the filing of their corporate income tax return. The level of contemporaneous compliance is generally highest in those jurisdictions with specific contemporaneous documentation requirements, namely Argentina (100%), Mexico (86%), India (78%) and the United States (75%). The level is generally the lowest in those jurisdictions that did not have contemporaneous documentation requirements at the time of this survey, including Italy (29%), France (25%) and Germany (14%).

The results for Canada, which has formal documentation requirements, were anomalous, with only 22% of parent respondents indicating that they prepare their transfer pricing documentation contemporaneously with the filing of the tax return. Figure 11 summarizes contemporaneous documentation practices by jurisdiction.

Figure 11: Contemporaneous documentation by parent company jurisdiction (parents)

Most respondents rely on regional comparables, but tax authorities increasingly require local comparables. More “glocalization” of benchmarking and comparables studies will be needed to mitigate audit risk.

Figure 9: Approach to comparables sets (parents)

Respondents’ reliance on regional comparables is somewhat surprising given the broadening range of local documentation requirements. The disconnect between regulatory trends and taxpayer practice is reflected in respondents’ audit experiences. Parent respondents cite insufficient local focus on comparables as the most frequent basis on which their documentation was judged inadequate upon audit (see Figure 10). Furthermore, nearly a third of respondents indicate that they were required to perform additional comparables analysis to identify local comparables. No doubt the hot topic of debate in transfer pricing compliance over the next decade will be how to reconcile the need for consistency and simplicity with diverging and increasingly detailed documentation requirements by tax authorities.

Figure 10: Basis on which documentation found inadequate upon audit (parents)

Pan-regional sets, but with exceptions for specific jurisdictional requirements Unknown

Pan-regional

comparables sets across multiple jurisdictions

Local comparables searches for all countries

4%

27%

38%

31%

2010 Global Transfer Pricing Survey

11

The risk of audit is rising ...

More survey respondents report that they have been subjected to a transfer pricing review. Sixty-eight percent of

parent respondents indicate their transfer pricing policy had been examined by tax

authorities, up from 52% in the 2007 Survey (see Figure 12).

Figure 12: Incidence of transfer pricing review (parents)

Respondents’ risk of audit varied depending upon their

intercompany transactions and their size. The establishment of limited risk distribution structures, material intercompany license transactions and company size are all positively correlated with the risk of transfer pricing review. These

findings are consistent with the application by tax authorities of a risk-based approach to transfer pricing reviews. The

larger the company, the larger the transfer pricing adjustment it typically yields. Intercompany licensing transactions and limited-risk distribution arrangements, which frequently

involve the conversion of a full-fledged distributor with existing marketing intangibles, are typically susceptible to larger

adjustments than tangible goods transactions or even service transactions.

While the level of transfer pricing reviews has increased

globally, the jurisdictions where those reviews have occurred have shifted since 2007. The United States and other mature transfer pricing jurisdictions head the list of jurisdictions where respondents had experienced a review, but China and India have shown a significant increase in audit activity. The countries showing a reduction in activity are generally those that face resource constraints, focus on a smaller number of high-profile cases or are revising their risk-based approach to case selection. Figure 13 summarizes the geographic distribution of the reviews experienced by respondents.

According to the survey results, there is now a 1 in 5 chance of suffering a material penalty compared with a one in 25 chance in 2005. The increasing imposition of penalties is a function of increasing tax authority resources, as well as tax authorities’ obvious need to raise more revenues. We expect the trend toward increased penalties to continue.

Taxpayers are responding to increased audit activity with an increased reliance on risk assessments.

Sixty-seven percent of parent respondents indicate they have conducted a risk assessment in the past three

years, an increase from 53% in the 2007 Survey.

Increasing numbers of respondents are experiencing the pains of transfer pricing audits globally. However , the range of countries in which audits occur is shifting, with mature transfer pricing jurisdictions apparently scaling back and emerging jurisdictions scaling up dramatically. The increasing pressure on governments to raise revenues and the dedication of additional

transfer pricing enforcement resources are likely to lead to reinvigorated scrutiny in all markets.

The survey results indicate a substantial increase since 2005 in the percentage of adjustments resulting in penalties, as summarized in Figure 14.

Figure 14: Percentage of adjustments resulting in penalties (parents)

0%

10%20%30%40%50%60%70%80%2010

2007

0%

5%10%15%20%2010

2007

2005

12

Addressing the challenges of globalization Published statistics from many tax authorities indicate record levels of APA applications overall. For example, the IRS is at a four-year high while the Canada Revenue Agency is at an all-time high.

The reported use of APAs in our transfer pricing surveys has nearly doubled since the inception of APA programs around the time of our 1999 Survey. The growth in APA use is a function of the increasing availability of APA programs and increasing realization of the value of APAs as dispute resolution tools. We predict that the use of APAs to resolve disputes and to reduce FIN 48 reserves will continue to trend upward. MNEs should consider the strategic use of APAs in both of these areas.

Although only 23% of parent respondents indicate using APAs as a controversy management tool, the level of satisfaction with the APA process among users is high. Ninety percent indicate that they would seek an APA in the future.

The range of jurisdictions in which parent respondents have sought APAs is wide (29 countries). But the principal APA

jurisdictions remain those with well-developed transfer pricing regimes, such as the United States, the United Kingdom, the Netherlands, Australia and Japan (see Figure 15).

Figure 15: Top five jurisdictions in which an APA has been used (parents)

… as the controversy management tool chest is growing

A taxpayer’s options for resolving transfer pricing disputes after domestic appeals were historically limited to three: APAs, competent authority relief (through the

Mutual Agreement Procedure provision of the relevant treaty) and litigation. Since the 2007 Survey, binding arbitration has arisen as an additional mechanism.

Seventy-nine percent of parents report that they are generally satisfied with the APA process. However , many remain

unconvinced (or unaware) of the benefits of APAs: fewer than half (47%) of parent respondents not already using APAs say they would consider using them in the future.

The 2010 Survey results show slightly increased reliance on the competent authority process, reversing a moderate trend from 2003 through 2007 of decreased reliance. While the trend from 2003 to 2007 may have resulted from the

increased availability of APAs and a general desire by taxpayers to manage controversy risk prospectively, the 2010 results may reflect a global trend toward increased bilateral and multilateral transfer pricing dispute resolution. Figure 16

summarizes the pattern over time.

The newly available binding arbitration process has yet to be used by a significant number of respondents, with only 14 parent respondents (2%) indicating they have pursued this option in a transfer pricing controversy.

Litigation of transfer pricing disputes remains infrequent, with only 11% of parent respondents overall pursuing this avenue. The only jurisdiction with significant litigation activity is India, where 50% of respondents have relied on litigation for the resolution of transfer pricing disputes.

As summarized in Figure 17, competent authority is the preferred method among parent respondents for resolving transfer pricing disputes.

Figure 17: Preferred methods of resolving transfer pricing disputes (parents)

T ransfer pricing rules are in flux

Regulations and resulting practice are in

flux all over the world. For example, during the last three years, both the OECD and the US Treasury issued significant new transfer pricing regulations or guidelines. Similarly, a wide range of countries — from Germany and Italy to Russia and China — have delivered or are at least in the process of implementing significant revisions to their rules and practices.

In the United States, the 2008 temporary cost-sharing regulations and the 2009 final service regulations reflect

the increased importance the IRS attaches to service and intangible transactions. These regulations also introduce a new level of sophistication, as evidenced by their sheer length in comparison to the original regulations they superseded.

The OECD’s revisions to Chapters I through III of the Transfer Pricing Guidelines signal a shift from the OECD’s historically strong preference for transactional methods toward accepting profit-based methods. The OECD’s Restructuring Chapter signals a new scrutiny of business restructuring transactions. Our survey responses reflect broad awareness of such developments. Sixty-two percent of parent respondents headquartered in OECD countries indicate awareness of the OECD discussion draft, Transfer Pricing Aspects of Business Restructuring. Awareness of the US cost-sharing regulations was high among US parent respondents at 66%. However,

the figure is a mere 28% among parent respondents with headquarters in other jurisdictions. Fifty-three percent of parent respondents indicate that they were altering their transfer pricing policies in response to regulatory changes. Based on our survey, taxpayers are not yet moving toward profit-based methods — even though such methods are increasingly preferred by tax authorities. Parent respondents instead continue to show a strong preference for transactional methods in establishing pricing for tangible goods, services and intangible goods (see Figures 18 through 20).Despite the increased importance of profit-based methods in the OECD and in many countries in transfer pricing audits, we still observe a minority of respondents using profit-based methods.

We predict that regulatory shifts will result in

a dramatic increase in the use of profit-based methods as corroborative, or sometimes primary, transfer pricing methods. We have already begun to see this trend in high-profile controversy cases. Survey readers should begin to consider the importance of profit-based methods in their

transfer pricing planning and documentation.

2010 Global Transfer Pricing Survey 13

14

Addressing the challenges of globalization Parent respondents also report more intrusive transfer pricing examinations with requests for all categories of documents and sources above their 2007 levels. In line with the

increased scrutiny of the commercial basis for intercompany pricing policies, tax authority requests for access to company operational personnel increased significantly from 36% in 2007 to 49% in the current survey. As tax authorities have expanded their analyses beyond a single party to examine effects on the profit of the counterparty, requests for foreign affiliate financial records and management accounts have increased. Intercompany agreements (not covered in the 2007 Survey) stood out as an almost universal request in transfer pricing audits.

While MNEs may not be consistent with current regulatory trends in their choice of transfer pricing methods, their prioritization of transactions susceptible to review is

aligned with the audit priorities established by the major tax authorities. Parent respondents ranked services, financing and intangible transactions as among the most susceptible to transfer pricing review (see Figure 21).

Parent respondents ranked services, financing and intangible transactions as among the most susceptible to transfer pricing review, and all categories of transactions as more susceptible to review than in 2007.

Tax authority examinations reflect the same

increased focus on service and intangible transactions, with intercompany loans also showing a striking increase in scrutiny. As shown in Figure 22, 42% of respondents that underwent a transfer pricing examination report that their intercompany financing was examined, up from only 7% in the 2007 Survey. Sixty-six percent report that their intercompany service transactions were examined, up from 55% in the 2007 Survey.

Figure 21: Transactions most susceptible to review by tax authorities (parents)

Figure 22: Most significant transfer pricing examination (parents)

Figure 23: Requests made in transfer pricing audit (parents)

2007

2010

2007

20102007

2010Internal documents relating to tax input on business change

Restructuring efforts and the pursuit of a more tax-efficient supply chain are becoming more complex

At precisely the time when companies need

to achieve greater efficiency in all areas

— business and tax alike — a number of

transfer pricing developments are presenting

challenges to MNEs who are restructuring

their businesses. The IRS, for example,

released a Coordinated Issue Paper on buy-

ins related to cost-sharing arrangements and

revised cost-sharing regulations. Similarly,

the OECD has issued its Chapter IX focusing

on business restructurings. At the same time,

the tax effects of business restructurings are

receiving increased scrutiny from the press

and the US Congress.

Our 2010 Survey queried respondents in detail on their

business change and restructuring activities. These questions

covered the nature of their business restructurings, the consideration of tax implications in business restructurings and the timing of restructuring activity.

Figure 24 presents the types of business changes undertaken by parent respondents since 2006 in total and by region.Cost reduction and IT system implementation or improvement projects were the most common categories of business change. The focus on cost reduction is unsurprising in the context of the current economic downturn. However, the prevalence of IT projects, which are typically costly, is somewhat unexpected. Outsourcing or off-shoring of supply chain functions were

the least prevalent business change projects among survey respondents.

Approximately half of all parent respondents have embarked on either supply chain optimization or centralization of business or management functions since 2006. The prevalence of these structures varies significantly by industry. In the chemical industry, for example, where products tend to be bulky and supply chains difficult to reengineer, 49% of parent respondents undertook supply chain optimization projects in the last four years. Respondents from the pharmaceuticals and telecommunications industries, on the other hand, indicate considerably higher levels of supply chain optimization.

With the increasing relative growth opportunities provided by emerging markets, companies are shifting focus to India, China and Brazil. Such shifts provide opportunities and motivation for supply

chain reengineering.

2010 Global Transfer Pricing Survey 15

16

Addressing the challenges of globalization Geographically, there are significant differences in business restructuring activity, with the Americas and EMEIA showing higher levels of all categories of business change than the APAC region. The rapidly changing global business footprint and its eastward shift suggest that the APAC region will require intense focus by tax departments in the coming years, as MNEs play catch-up to accomplish in the APAC region what they already have in EMEIA and the Americas.

There is little regional variation in the relative ranking of business change projects. However , there are marked, if not surprising, variations in the absolute levels of business change implementation. The EMEIA and Americas regions return very similar levels of activity, while APAC respondents, where companies tend to be less mature, indicate significantly lower levels of business change.

The survey reveals that a significant portion of business restructurings involve intangibles. Given governments’ focus on intangibles — both incentives to retain or attract to their jurisdictions (e.g., the recent UK announcements on the patent box) and enforcement efforts — we can expect continued examination, controversy and litigation activity in this area.

Figure 25: Centralization of management and supply chain optimization by industry (parents)

Supply chain optimization

Centralization of business or management functions In spite of greater complexity and added documentation requirements, companies are still pursuing a wide array of business restructuring, streamlining and supply chain reconfiguration due to business necessity. Figure 26 summarizes the business restructurings that parent

respondents have implemented, both in total and by region.

2010 Global Transfer Pricing Survey

17Figure 28 summarizes the timing of parent respondents’

business restructuring activities.

The 2005–2010 period saw an upsurge in restructuring activity after a lull in the 2001–2004 period. Centralization of intangible property management, in particular , rebounded during the 2005–2010 period with a 36 percentage point increase. Other forms of planning related to intangible

property, such as contract R&D, also increased in the 2005–2010 period. Regional procurement companies, which were among the least popular forms of planning before 2005, have moved into first place among planning structures.

Given the significant role intangibles play in today’s businesses, restructurings focused on intangibles, including contract R&D, are particulaly prevalent. Less popular are centralized procurement and global or regional principal structures. Limited-risk manufacturing structures are the least common forms of restructuring. This is not surprising because many companies have already established manufacturing in low-cost, tax-competitive jurisdictions, employ “manufacturing-lite”

business models or are not involved in manufacturing activities at all.

Again, the survey shows that respondents are generally aware of the need to consider tax implications in the planning and implementation of business restructuring projects. Figure 27 summarizes the consideration of tax implications in the various

categories of business change.

Awareness of the need to consider tax implications is foremost in post-merger integration (91%) and outsourcing/off-shoring (81%) projects.

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