Tue, Aug 7, 2018

Transfer Pricing Times: OECD Publishes Discussion Draft on Financial Transactions

In this issue: the OECD released the first public discussion draft on the transfer pricing of financial transactions; a summary of the 2018 National Association for Business Economics transfer pricing conference; the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting entered into force; the U.S. Internal Revenue Service's Large Business & International Division released the Transfer Pricing Examination Process; the Inland Revenue (Amendment) (No. 6) Bill 2017 came into effect in Hong Kong; and Vietnam issued new regulations on technology transfers and challenges for related party royalty payments.


OECD Publishes Discussion Draft on Financial Transactions

On July 3, 2018, the Organisation of Economic Co-operation and Development (“OECD”) released the first public discussion draft on the transfer pricing of financial transactions. This Discussion Draft contains the first official OECD detailed comments and guidance on transfer pricing aspects of financial transactions, and can be found here.

The draft addresses specific issues related to the pricing of financial transactions such as treasury function, intra-group loans, cash pooling, hedging, guarantees and captive insurance.

Comments on the discussion draft are invited by September 7, 2018. They will be made publicly available and are expected to be discussed by the OECD during November of 2018.

The Interaction of Financial Transactions with Section D.1. of Chapter 1 of the OECD Transfer Pricing Guidelines

Capital Structure
Following the introduction, the Discussion Draft first focuses on the accurate delineation of the actual transaction under Chapter I, and states that the former will precede any attempt to price interest on debt, although other approaches (e.g. multi-factor analysis) may be used too in addressing issues of capital structure.

The accurate delineation of the actual transaction is also said to consider (a) the factors affecting the performance of the business in the industry sector where the MNE operates (e.g. industry life cycle, government regulations, availability of financial resources) and (b) how they respond to these (e.g. prioritisation of funding needs, strategic significance of entity within the group, credit rating or debt/equity targets and funding strategy relative to the industry sector).

The Draft mentions examples of economically relevant characteristics that may be useful indicators for accurate delineation of an advance of funds, including the presence or absence of a fixed repayment date, the obligation to pay interest, the right to enforce payment of principal and interest, the existence of financial covenants and security, the source of interest payments, the ability of the recipient of the funds to obtain loans from unrelated lending institutions, the extent to which the advance is used to acquire capital assets, and the failure of the purported debtor to repay on the due date or to seek a postponement.

Economically Relevant Characteristics of the Transaction
The main characteristics of financial products or services are said to be very diverse and thus to affect their pricing. Using intra-group loans as an example, it presents the following characteristics as the primary ones to consider when accurately delineating a financial transaction: the amount of the loan; its maturity, schedule of repayment, nature or purpose of the loan (trade credit, merger/acquisition, mortgage, etc.), level of seniority and subordination, geographical location of the borrower, currency, collateral provided, presence and quality of any guarantee and interest rate type (fixed or floating).

Regarding contractual arrangements, it is stipulated that although necessary these may not be sufficient if the real conduct of related parties is not reflected and or these do not provide enough detail. Hence, other documents should be reviewed.

With respect to the fourth comparability factor; economic circumstances, great emphasis is placed on the importance of ensuring that markets in which the independent and associated enterprises operate are as analogous as possible, or otherwise to have the pertinent adjustments made. Although reference is made to factors like currencies, geographic locations, local regulations, business sector of the borrower; and the timing of the transaction, macroeconomic factors appear to be the pivotal ones.

Risk Free Rate of Return
Preceding the topic of treasury functions, the Draft presents informal comments on risk-free rate of return and risk-adjusted rate of return. Commentators then propose the interest rate on certain government issued securities as a reference to risk-free return, while still considering the relevant product characteristics (mentioned above) applicable to all financial instruments (e.g. maturity, currency, etc.). Still, where the funder assumes some financial risks, commentators suggest the addition of a premium to the risk-free return reflecting these risks.

The Treasury Function 
The Draft defines treasury functions as being a “support service to main value-creating operations”. In this regard, the general guidance on intra-group services can be applied. However, it is noted that group treasury may sometimes make key decisions with regard to risk management and investments.

The Draft remarks that the three main treasury activities often performed within MNE groups are intra-group loans, cash pooling and hedging activities.

Intra-group Loans
As mentioned, commercial and financial relations, and the economically relevant characteristics of the transaction, from both the lender’s and borrower’s perspectives should be considered.

A lender needs to decide whether to make a loan, how much to lend, and on what terms. Hence lenders’ main concerns are regarding the borrower’s creditworthiness, credit risk, wider economic factors (e.g. interest rates), and other options realistically available (opportunity cost).

Credit Rating

Credit ratings can serve as a useful measure of creditworthiness and so help to identify potential comparables. Both commercial tools and in-house models can be used in calculating this rating. However, these tend to have a series of limitations (e.g. over-reliance on parameters, their high quantitative nature, lack of clarity on the process and hard to estimate for start-up companies and special vehicles). It is stated that credit rating methodologies applied by independent rating agencies to determine official credit ratings are based on far more rigorous analysis.

Effect of Group Membership

The Discussion Draft recalls the need to consider the potential impact of passive association between entities when assessing a related-party’s creditworthiness and invites commentators to bring up new approaches and or consider the appropriateness of existing ones such as, the use of either a credit rating at the group level for each member, or using the former merely as a starting point prior to notch up or notch down adjustments.

Further, it leaves open to discussion whether the relative importance of an entity to the overall group should affect the former’s rating.

Covenants, Guarantees, Loan Fees and Charges
Other elements that need to be considered in the arm’s length pricing of intra-group loans, as stated in the Discussion draft, include: covenants, guarantees and loan fees and charges. The Discussion Draft does not in fact place too much attention to these, although from the lender’s perspective these are important considerations directly linked to their financial protection, and from a borrower’s perspective, the availability of any of these can suppose an upgrade of their credit profile.

From a transfer pricing valuation angle, the key considerations here included the importance of evaluating guarantors in the same ways as the original borrower would, and where a guarantee exists and where arrangement or commitment fees exist, these should be evaluated in the same way as any other intra-group transaction.

Pricing Approaches in Determining an Arm’s Length Interest Rate

In line with Chapter II of the OECD Guidelines, “the selection of the most appropriate method should be consistent with the actual transaction as accurately delineated, […] through a functional analysis”. Given the “widespread existence of markets for borrowing and lending money and the frequency of such transactions between independent borrowers and lenders” the CUP method is recommended, as the tested loan can be easily benchmarked against publicly available data of other borrowers (that could be related-party entities borrowing from independent lenders) with the same credit rating for loans and resembling comparability factors.

Yet, while “bank opinions” should not be thoroughly applied in determining intra-group loan pricing, internal comparables should not be disregarded, and neither should be the cost of funds approach, especially, where only intermediary functions are performed.

Cash Pooling
Views are invited regarding the possible approaches for allocating the cash pooling benefits to the participating cash pool members.

The discussion draft suggests that the accurate delineation of cash pooling arrangements needs to consider not only the facts and circumstances of the relevant balances, but also the context of the arrangements as a whole.

A key point is whether it is appropriate for the transaction to be treated as a short-term cash pool balance, or whether the characteristics support an alternative view such as being a long-term deposit or loan.

Rewarding the Cash Pool Leader
With regards to the pool leader, there is no consensus on the Discussion Draft on the pooling benefit to be allocated to a pool leader, however, via presentation of two examples, reference is made to the correct allocation based on the facts and circumstances, functions performed, assets used, and the risks assumed in effectuating the cash pooling arrangement.

Rewarding the Cash Pool Members

Three approaches can be envisaged by the Discussion Draft for allocating the cash pooling benefits across cash pool members. These approaches are subject to specific facts and circumstances of each pool, and include: enhancing interest rates for all participants, applying the same interest rate for all participants with equivalent credit ratings and allocating the cash pooling benefits to depositors facing potential credit risks.

Intra-group financial transactions may include instruments, such as hedging arrangements as a means of mitigating exposure to risks (e.g. foreign exchange or commodity price movements). This is a tricky area from the transfer pricing perspective, given that where treasury functions (i.e. hedging functions) are centralized, the overall group might have risks hedged, but at the per entity level, this might not be the case. Thus, closer scrutiny is required regarding the matter of how to treat risk.

The Draft Discussion makes a distinction between guarantees used as a means for a borrower to enhance its credit rating (due to passive association to a higher rated potential guarantor) relative to those to increase its borrowing capacity or lower the interest rate on the existing borrowing capacity. The former would not be regarded as a service provision, and thus would not be allocated any service fee payable.

Determining the Arm’s Length Price of Guarantees

As with intra-group loan transactions, the internal or external CUP method is advised, although publicly available and comparable guarantee data is more limited.

In considering the comparability between controlled and uncontrolled transactions, factors affecting the guarantee fee should be accounted for (e.g. borrower’s risk profile, terms and conditions of the guarantee, term and conditions of the underlying loan (amount, currency, maturity, seniority etc.), credit rating differential between guarantor and guaranteed party, market conditions, etc.

Regarding the pricing of guarantees, four alternative methods are mentioned. The first of them is the “yield approach”, this approach quantifies the benefit that the guaranteed party receives from the guarantee in terms of lower interest rates. The method calculates the spread between the interest rate that would have been payable by the borrower with and without the guarantee. The other methods are the “cost approach”, the “valuation of expected loss” and the “capital support method”.

Captive Insurance 
The Draft suggests that an actuarial analysis may be an appropriate method to independently determine the premium likely to be required at arm´s length for insurance of a particular risk.

The Discussion Draft shows the view of the OECD in terms of addressing financial transactions and leaves room open for commentator’s opinions.

Financial transactions are crucial to both individual entities composing a multinational group but also to the economic wellbeing of the group. Given the ever-changing global financial transactions transfer pricing environment, whereby tax authorities have shifted attention to substance over form, it is important to adopt intra-group financing policies that comply with tax authorities’ judgement. Whence, the triviality of appropriate pricing in accordance to the arm’s length conditions of these transaction type, as well as, the underlying reason as to why this topic remains in the lips of most MNEs and transfer pricing practitioners today.

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Summary of 2018 NABE Transfer Pricing Symposium

The National Association for Business Economics (“NABE”) transfer pricing conference was held in Washington, D.C. from July 17-19, 2018. The topics at this year’s NABE symposium were primarily focused on the recent U.S. Tax Cuts and Jobs Act (“TCJA”) and its effects on transfer pricing. Leading professionals from business, government and advisory firms discussed and debated hot transfer pricing issues during the symposium, which concluded with a keynote address by Jennifer Best, Director of IRS Treaty and Transfer Pricing Operations.


  • During a discussion on new types of income allocations mandated by TCJA, the panel debated the scope of the services cost method (“SCM”) exception under the TCJA in the context of the base erosion anti-abuse tax (“BEAT”) payment – particularly the interpretation of the statutory language and its meaning as it relates to the treatment of services costs vs. the mark-up component of charges. The panel noted that further guidance, at least a draft version, providing specifics on BEAT is expected to be issued by the IRS and Treasury by the end of this year and should provide more clarity on this question. 
  • In a keynote address, Roberto Schatan, a senior economist at the IMF, shared his concern regarding the use of a one-sided method when there is an “unexplained profit” in a transaction, arguing that the profit split method should be used in such instances. Schatan indicated that the guidance provided by the OECD is not clear on how to evaluate risk and assess who has control over the risk, in a way controversially allowing global enterprises to choose which entity has high or low risk depending on the tax jurisdiction rules. Schatan concluded his keynote address by stressing that more fundamental revisions or alternatives will be required to understand the risk in arm’s length principles such that allocation and/or isolation of the risk is not done arbitrarily. The perspective shared gave the audience a view into the way that developing countries tend to think about one-sided methods and the appropriateness of the profit split and highlighted the tension that might exist between those views and an arguably more restrained view coming out of the OECD guidance on the Transactional Profit Split Method (“TPSM”) as part of the BEPS project.
  • In a discussion of the impact of Tax Reform on IP valuation, the panel discussed the economic perspectives on the effects of aggregation and realistic alternatives principles. In particular, Duff & Phelps' Managing Director, Mark Bronson, noted that, “the broadened definition of intangibles, and the inclusion of the realistic alternatives aggregation principles in the statute could lead to the use of a longer useful life than might have occurred under earlier guidance” indicating that alternative paradigms for valuation analyses relying on market-based evidence would need to be considered as a result of TCJA to ensure that overzealous application of terminal values didn’t lead to non-arm’s length results. A senior economist at the Treasury agreed that it is time to start thinking about market multiples and market comparables more often to give us alternative views of value. Other panelists added that defining the scope of IP being transferred and delineating the transaction in the intercompany agreement becomes even more crucial.
  • A panel on a topic of Transfer Pricing in the Digital Age discussed challenges of the digital economy for transfer pricing. The panel including a tax official from Dell Technologies, who argued that traditional transfer pricing frameworks are difficult to apply to price intercompany transactions in the digital economy because of the complexity of the business model requiring attribution of value across multiple drivers such as hardware, software and services and the dispersion of resources contributing to those drivers.
  • A U.S. representative of the OECD Working Party reiterated that interpretation of the revised OECD TPSM guidance should not be read to say that the profit split method should be the default method; rather, the revised guidance provides three general features of a transaction that may trigger the use of the profit split method: (i) if each party makes unique and valuable contributions, (ii) if business operations are too integrated to evaluate the contribution of each party separately, or (iii) if each parties share significant economic risks. The OECD, it was asserted, “did try to show these were high bars” by including examples that provide helpful direction without allowing tax administrations to use the profit split method disproportionately.
  • Jennifer Best, Director of IRS Treaty and Transfer Pricing Operations, emphasized the importance of a robust and comprehensive transfer pricing documentation report during her keynote address. Best shared a few examples of “bad” documentation, which included a limited functional analysis and lack of comparability analysis. Best noted that the IRS team has seen quite a few reports with “a list of functions but no real analysis.” Further, Best indicated that some reports simply lack explanations or concrete reasoning. She specifically noted the selection of profit level indicator (e.g., why an operating margin was selected for a distributor) and comparability adjustment (e.g., why an over capacity adjustment was performed) as common areas lacking reasoning.

On the other hand, Best also shared an example of “good” documentation. Best and her team have received reports with a clear summary presented upfront, listing all of the intercompany transactions, relevant entities, the transfer pricing methodology selected, and the results. A robust and comprehensive report such as this one would help the IRS “deselect” work and focus on the right work, Best noted.

All of the points are related to the IRS’s emphasis on deselecting work in an effort to focus on issues that deserve more time and attention, especially given its budget and resource constraints.

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Multilateral Convention to Implement Anti-BEPS Measures Enters Into Force

Following ratification by five signatories, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (also known as the “Multilateral Instrument” or “MLI”), which formed the subject of Action 15 of the BEPS Action Plan, entered into force on July 1, 2018. The MLI was conceived as a fast-track method for enacting the tax treaty-related conclusions of the BEPS Project, sidestepping detailed renegotiation of multiple individual bilateral tax treaties.

The MLI is the first step in a process for implementing bilateral tax treaty changes designed to reduce tax avoidance by multinationals. Treaty measures included in the MLI address such matters as hybrid mismatch arrangements, treaty abuse and strategies to avoid the creation of a permanent establishment.

The OECD states that 83 jurisdictions have now signed the MLI, covering over 1,400 bilateral tax treaties, but implementing the amendments will be a staggered process. The initial phase is limited to the first five of the jurisdictions to ratify the MLI: Austria, the Isle of Man, Jersey, Poland and Slovenia. Effective treaty changes brought about by the MLI will not occur until 2019: for the existing bilateral tax treaties of these five jurisdictions that are affected, the MLI will have effect from January 1, 2019.

Both signatories must have ratified the MLI for the provisions of their mutual tax treaty to be affected. Only three bilateral tax treaties are therefore currently affected: those between Austria/Poland, Austria/Slovenia and Poland/Slovenia.

Four other nations (Serbia, Sweden, New Zealand and the United Kingdom) ratified the MLI after the initial five ratifications. For these later four jurisdictions, the MLI will become effective on October 1, 2018, increasing the number of bilateral tax treaties covered by the MLI to fourteen, with the addition of Austria/Serbia, Poland/Serbia, Poland/Sweden, Poland/New Zealand, Poland/UK, Slovenia/Serbia, Slovenia/UK, Serbia/UK, Sweden/New Zealand, Sweden/UK and New Zealand/UK. For withholding tax purposes, the changes will be effective January 1, 2019, but for all other taxes the changes will not take place until April 1, 2019.

The MLI implements the tax treaty-related aspects of the BEPS minimum standards. However, there are some treaty provisions that were optional, in which case both jurisdictions party to a bilateral tax treaty must have adopted matching positions for the change to apply to the treaty. This creates complexity in assessing the modifications by the MLI to any one bilateral tax treaty. The OECD has created a five-step application process and a matrix detailing each signatory to the MLI’s options and reservations, as a way of assisting identification of which MLI provisions apply to a covered tax agreement.

A business-friendly aspect of the MLI is the strengthening of the provisions to resolve treaty disputes, particularly through mandatory binding arbitration, for which 28 signatories opted. Of the initial nine jurisdictions to ratify the MLI, those committing to mandatory binding arbitration are Austria, New Zealand, Slovenia, Sweden and the United Kingdom.

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LB&I’s Issuance of the New Transfer Pricing Examination Process

On June 29, 2018, The U.S. Internal Revenue Service (“IRS”)’s Large Business & International Division (“LB&I”) released the Transfer Pricing Examination Process (“TPEP”) which provides a framework and guide for transfer pricing examinations. The TPEP replaced the Transfer Pricing Roadmap (“Roadmap”), originally issued in February of 2014, and can be found here.

The TPEP, issued by the Treaty and Transfer Pricing Operations division of LB&I, provides guidelines on best practices and processes to assist IRS agents while conducting transfer pricing examinations. Primarily designed as a tool to be used by IRS agents, these guidelines also help taxpayers with the planning, execution, and resolution of transfer pricing examinations. Similar to the Roadmap, the TPEP divides transfer pricing examinations into three distinct phases: the planning phase, the execution phase, and the resolution phase. For each phase, the TPEP describes the types of materials to be reviewed, processes to be followed over the course of the examination, and the types of analyses that should be completed to reach a resolution.

The Planning Phase
This phase of the examination process conducts an initial risk assessment and determines the scope of the audit. An assigned team (“Issue Team”) compiles an Information Data Request to be sent to the taxpayers. Items requested include, but are not limited to, accounting records, tax and legal organizational charts, segmented accounting data, and financial statements (if available). In addition, the Issue Team reviews materials including the prior year workpapers; the income tax return; the country-by-country report; the taxpayer’s information obtained through its website, Form 10-K or Form 20-K filed with the SEC, and the internet. The Issue Team then prepares the ratio analysis and develops a “preliminary working hypothesis” that identifies specific transactions between the U.S. taxpayer and its affiliates that require an examination to be performed. The collaboration with Advance Pricing Mutual Agreement Program (“APMA”), if applicable, will occur during this phase.

The Execution Phase
Under the execution phase, the Issue Team aims to determine facts of the underlying examination, apply law to those facts, and understand the taxpayer and various implications of the issue in more detail. This involves several meetings with the taxpayer in order to help the Issue Team resolve any factual differences and assess the transfer pricing issue at hand.

Under this phase, the Issue Team will review the taxpayer’s IRC Section 6662(e) documentation, hold reassessment meetings, review intercompany agreements, conduct functional analyses, and perform economic analyses consistent with the working hypothesis in order to evaluate the taxpayer’s best method analysis. The TPEP also instructs the Issue Team to hold frequent meetings throughout the execution phase with LB&I Division Counsel, IRS Practice Network members, and their respective managers to discuss any new information and reassess or adjust the IRS’s working hypotheses to further develop specific transactions or issues. As part of the execution phase, the Issue Team prepares a draft report based on the functional analysis performed and continues to build a notice of proposed adjustments (“NOPA”), if applicable.

The Resolution Phase
The goal of the resolution phase is to reach agreement between the taxpayer and the IRS, if possible, on the tax treatment of each issue examined and, if necessary, issue a Revenue Agent Report (“RAR”) to the taxpayer. The RAR contains all the necessary information regarding the adjustments and tax liability computation.

During this phase, the TPEP anticipates additional meetings between the taxpayer and the Issue Team to discuss results of all issues and evaluate the taxpayer’s position with a focus on identifying the remaining disputed facts and/ or legal arguments prior to finalizing the NOPA and the Economist Report.

If no agreement is reached, the Issue Team finalizes the NOPA and the Economist Report and issues the RAR along with the 30-day letter.

In case no agreement is reached between under the resolution phase, taxpayers have the opportunity to file an appeal (also referred to as a “Protest”) within 30 days from the date of the letter. If a Protest is submitted, the Issue Team will review the Protest, prepare a rebuttal, and begin preparing for the pre-Appeals opening conference.

Final Thoughts
The TPEP is meant to provide IRS agents and taxpayers with guidelines and best practices for transfer pricing examinations. Every transfer pricing case is unique and requires ongoing exercise of judgment and discretion when applying the TPEP framework. The TPEP will be updated regularly based on feedback from examiners, taxpayers, practitioners, and others.

At a recent Transfer Pricing Symposium hosted by the National Association of Business Economics (“NABE”) Jennifer Best, Director of IRS Treaty and Transfer Pricing Operations, briefly touched on TPEP, and declared that she believed the new process to be user friendly and allows taxpayers and the IRS to share best practices.

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Hong Kong Legislates Long-Awaited Transfer Pricing Framework

On July 13, 2018, the Inland Revenue (Amendment) (No. 6) Bill 2017 (“Amendment Bill”) came into effect in Hong Kong, implementing BEPS-driven transfer pricing initiatives into Part 8AA of the Inland Revenue Ordinance (“IRO”). The new rules in the Amendment Bill affirm Hong Kong’s commitment to the OECD’s BEPS Action Plan recommendations, of most interest to taxpayers being the adherence to the arm’s length principle and increased transfer pricing compliance requirements.

Arm’s Length Principle
The Amendment Bill formalizes the use of the arm’s length principle into Hong Kong tax law (these principles formerly existed as guidelines in Departmental Instruction Practice Note No. 46 (“DIPN 46”)), empowering the Inland Revenue Department (“IRD”) to adjust transfer pricing arrangements where related party transactions are deemed to be inconsistent with the arm’s length principle and have resulted in a tax advantage to the taxpayer. Where a tax advantage is identified, the transfer pricing rules may apply to deem the transaction to have taken place under an arm’s length transfer pricing arrangement and empower the IRD to make an adjustment on this basis.

It is important to note that the Amendment Bill will also apply to domestic arrangements, with broad exemptions in place to ensure that only high-risk transactions are caught. In particular, only domestic transactions giving rise to an actual difference to the Hong Kong tax base will be subject to the transfer pricing rules. The most commonly observed example would be where the two entities have a different tax profile due to carry forward losses or the application of an offshore tax exemption.

Increased Compliance Requirements

Hong Kong will also adopt the three-tier documentation framework (i.e. master file, local file and Country by Country Report or “CbCR”) recommended by BEPS Action 13. This will introduce formal transfer pricing documentation requirements to certain Hong Kong taxpayers.

Smaller taxpayers will be exempt from the master file and local file if they satisfy one or both of the following tests:


Business size test

RPT size test

Taxpayers will be excluded from preparing any transfer pricing documentation if two of the following three criteria are met:

Taxpayers will be excluded from documenting a specific category of transaction in their Local Files if the applicable criteria for each category is met

a) Total annual revenue does not exceedHKD 400m

a) Annual amount of buy-sell transactions of tangible goods do not exceed HKD 220m

b) Total value of assets does not exceed HKD 300m

b) Annual amount oftransaction in respect of financial assets /transfer of intangible assets do not exceedHKD 110m

c) Average number of employees does not exceed 100 people

c) Annual amount of other transactions exceedingHKD 44m

Taxpayers should be aware that the master file and local file documentation requirements retrospectively apply for financial years starting from or after April 1, 2018.

Hong Kong taxpayers that are members of groups whose annual consolidated revenue exceeds HKD 6.8 billion may be required to file a CbCR if they are the ultimate parent entity of the group or are nominated as the surrogate filing entity. The documentation requirements for the Country-by-Country Report apply for financial years starting on or after January 1, 2018.

Increased Penalties
The Amendment Bill also introduces administrative penalties up to 100% of the undercharged tax where incorrect statements are disclosed on a tax return using incorrect transfer pricing information.

In more severe cases of non-compliance with the Country-by-Country Reporting obligations, the IRD is able to seek criminal charges against directors and tax agents of the offending entity.

Following the introduction of the DEMPE framework into Chapter I of the OECD Transfer pricing guidelines, the new Amendment Bill Section 15F has introduced deeming provisions to align the definitions of ‘legal ownership’ and ‘economic ownership’. Under the new provisions, where the Hong Kong taxpayer performs the DEMPE functions but does not hold legal title or receive an arm’s length return, the IRD may deem the intangible related income attributed to another group entity with legal title to be a taxable receipt of the Hong Kong taxpayer, irrespective of where such income is ‘sourced’ under Hong Kong general tax principles.

It is currently unclear how the deeming provisions will be implemented, and the IRD is expected to release further guidance on this topic shortly.

Attribution of Profits to a Permanent Establishment (“PE”)

The new rules further confirm Hong Kong’s adherence to the accepted OECD PE principles, by affirming the use of the separate entity concept, treating and taxing any PE operating in Hong Kong as if it were a distinct and separate enterprise operating in Hong Kong. The ‘Authorized OECD Approach’ has also been adopted as the recognized method of attributing profits to a Hong Kong PE, therefore requiring a well-documented functional analysis be prepared to attribute profit to a PE according to its economic substance (relative to the PE’s head office).

Advance Pricing Arrangements (“APA”)
Hong Kong previously included guidance on the application of a bilateral and multilateral APAs, with unilateral APAs considered in exceptional circumstances only. The new rules, contained in Sections 50AAP – 50AAW serve to legislate the existing APA regime with the intention of enticing more taxpayers into entering APAs, thereby securing tax and transfer pricing certainty for both the IRD and the taxpayer. While the new administrative procedures underlying the application for an APA are broadly in line with the existing framework, it should be noted that the new rules allow unilateral APAs in more cases. In addition, the application is no longer subject to a fixed application cost, and instead is calculated on the hourly rates of the IRD case officers, capped at a maximum of HKD 500,000.

Dispute Resolution 
Additionally, the Amendment Bill introduces a statutory dispute resolution mechanism by way of Mutual Agreement Procedure. While any proposed double tax relief must be negotiated and effected by the Commissioner, the new law is comforting to taxpayers in that cases can be further referred for arbitration under a relevant CDTA.

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Vietnam Issues New Regulations on Technology Transfers and Challenges for Related Party Royalty Payments

The new Law on Technology Transfer No.07/2017/QH4 (Law 07/2017) (replacing Law on Technology Transfer No.80/2006/QH11 (Law 80/2006)) and Decree 76/2018/NĐ-CP (Decree 76) both effective from July 1, 2018 have provided legal basis for stricter requirements and challenges for related party royalty payments in Vietnam.

Law 07/2017, Decree 76, and subsequent guidance in the latest draft circular provide clearer stipulations on compliance requirements including the registration of technology transfer contract (“TTC”), payment and audit of technology transfer fee/royalty, etc.

We summarize key highlights and recommendations on these matters below.

  1. Registration of TTC: Royalty will be deemed as nondeductible for income tax purpose if the TTC is not duly registered
    • It is required that a taxpayer’s TTC must be registered to government agencies for any type of technology transfer from overseas to Vietnam that covers technology transfer contribution in certain cases, especially investment projects, capital contributions, commercial franchises, and purchases/sales of machinery and equipment with attached technology content (see Articles 4, 5-2, and 31-1, Law 07/2017);
    • The registration is also encouraged for other types of technology transfers;

    • The registration requirement is applicable for agreements starting from July 1, 2018 onwards, including any TTC which will be renewed after July 1, 2018;

    • Both the TTC and the actual technology transfer can only be implemented after the Ministry of Science and Technology (MOST) has issued the certificate of successful registration (including the case of renewed agreements of technology transfer), and it may take days for the certificate issuance.

    Risks triggered from the new registration requirement:

    As the compulsory conditions that trigger registration under Article 4, 5 and 31 of Law 07/2017 could be interpreted in a broad understanding, tax authority may view any unregistered TTC as unacceptable. The superseded Law on technology (Law 80/2006) did not strictly require the registration of TTC. Thus, those TTC which were signed previously but renewed on annual basis may be overlooked by enterprises while in fact these routine TTC must also be registered under the new regulations. Enterprises may conduct the technology transfer and even the make payment of any charges under the TTC without notice of the new requirements or make a late registration. In both cases of non-registration or late registration of the TTC (or the renewal of the TTC), any type of charges (including but not limited to technology transfer fee royalty, technical support fee, etc.) would be deemed as nondeductible for corporate income tax purpose.

  2. Price testing requirement for technology transfer between related parties

    • Clause 3, Article 27 of Law 07/2017 stipulates that any price/ charge regarding the technology transfer between related parties (as defined by tax regulations) must be tested upon tax authority’s requests.
    • The testing of a transfer price for technology must be done by a competent and certified organization/agency among those listed on MOST’s website. However, as of July 2018, there has been no organization listed due to very high requirements for qualifying as technology price valuation agency, and due to the unavailability of relevant training programs by MOST.
    • Law 07/2017 and Decree 76 stipulate that the testing of price/ charge relating to the technology transfer must be done in accordance with transfer pricing regulations, i.e., Decree 20/2017/ND-CP effective from May 1, 2017.

    Transfer pricing risks from testing requirement of price in technology transfer agreements:

    With the advent of the TTC registration requirement as well as payment requirements, taxpayers will need to conduct a comprehensive report and benchmarking analysis to justify the price and nature of related party technology transfers. It is noted that the report and the benchmarking study, would serve as a defense documentation during an audit.

  3. The preparation of registration form for technology transfer and supporting documents

    For technology transfer agreements with related parties that are subject to compulsory registration, enterprises will have to prepare a registration Form (i.e. Form 01) including supporting documents to submit to MOST.

    Form 01 has several sections which will need to be consistent with the supporting documentation and benchmarking study or risk the technology transfer being rejected by both MOST and the tax authority.

    Those key sections in Form 01 which would trigger issues include, but not limited to:


    • Section No.4: Methods of technology transfer (i.e. via documents, training, experts, etc.)
    • Section No.5 Scope of technology transfer (i.e. transfer of intellectual property, exclusive or nonexclusive transfer, etc.)
    • Section No.6: Value of technology transfer (i.e. separation of value with regards to each technology factor such as training, know-how, software, technical support, etc.)
    • in Section 6 of Form 01 may put companies at significant transfer pricing risks if it is made without proper supporting evidence or justification.

    Our recommendations for enterprises which have technology transfer with related parties:

    • Revisit existing TTC to identify whether these TTC or the amendments/ renewal of such TTC fall into compulsory registration provisions.
    • Review the availability of documents and information to evidence the nature of technology transfer before filling Form 01.
    • Complete registration for new technology transfer agreements and/or existing agreements with automatic renewal date after July 1, 2018 as soon as possible.
    • While there is not yet any clearer instruction from tax authority or from most on the testing requirement and procedure of technology transfer transactions, enterprises would seek to prepare clarification report to explain the nature of technology transferred, accompanied by relevant benchmarking study (for example testing the royalty rate using commercial database) that compares the price in such transactions with similar independent agreements.

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1 The Tax Court Case was Altera Corp. v. Com’r., 145 T.C. 91 (2015)
2 T.D. 9456, 1.482-9 Treatment of Services Under Section 482; Allocation of Income and Deductions from Intangible Property; Apportionment of Stewardship Expense (26 CFR Parts 1 and 31, and 602)
3 H.R. 1, Public Law 115–97 (12/22/2017)
4 T.D. 9568, 1.482-7 Section 482: Methods to Determine Taxable Income in Connection With a Cost Sharing Arrangement (26 CFR Parts 1, 301 and 602)
5 We note that the Ninth Circuit did not try and apply the regulations retroactively in the Xilinx case, and we hear again Judge Foley’s comments in the opinion in the Veritas case about taxpayers needing to be “compliant but not prescient”.
6 Consideration the realistic alternatives of the parties and aggregation were both part of the 1994/1995 rewrite of the Treasury regulations under IRC §482 but the terms were only added to the language of IRC §482 as part of the TCJA at the end of 2017.
7 FAR 31.205-6(i) deems compensation based upon stock performance strictly an unallowable cost, stating in part: “Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.”
8 The Tax Court Case was Altera Corp. v. Com’r., 145 T.C. 91 (2015)
9 The inclusion of much of the substance of these changes in the tax code as part of the Tax Cut and Jobs Act of 2017 may possibly have mitigated the likelihood of such a challenge

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