Tag: Business restructuring

In a transfer pricing context these transactions are defined as the cross-border redeployment of functions, assets (tangible and/or intangible) and risks to which a profit/loss potential may be attached. It is often the case that intangibles are transferred in connection to business restructurings leading to significant audit risk.

France vs SA Tropicana Europe Hermes, August 2022, CAA of DOUAI, Case No. 20DA01106

France vs SA Tropicana Europe Hermes, August 2022, CAA of DOUAI, Case No. 20DA01106

SA Tropicana Europe Hermes is a French permanent establishment of SA Tropicana Europe, located in Belgium. The French PE carried out the business of bottling fruit juice-based drinks. In 2009, a new distribution contract was concluded with the Swiss company FLTCE, which was accompanied by a restructuring of its business. Before 1 July 2009, Tropicana was engaged in the manufacture of fresh fruit juices in cardboard packs and purchased fresh fruit juices which it pasteurised. As of 1 July 2009, its activity was reduced to that of a contract manufacturer on behalf of FLTCE, which became the owner of the technology and intellectual property rights as well as the stocks. The re-organisation led to a significant reduction in the company’s turnover and profits. Tropicana Europe was subject to two audits, at the end of which the tax authorities notified it of tax reassessments in respect of corporate income tax, withholding tax and business value added contribution (CVAE) for the years ... Read more
Israel vs Medingo Ltd, May 2022, District Court, Case No 53528-01-16

Israel vs Medingo Ltd, May 2022, District Court, Case No 53528-01-16

In April 2010 Roche pharmaceutical group acquired the entire share capital of the Israeli company, Medingo Ltd, for USD 160 million. About six months after the acquisition, Medingo was entered into 3 inter-group service agreements: a R&D services agreement, pursuant to which Medingo was to provide R&D services in exchange for cost + 5%. All developments under the agreement would be owned by Roche. a services agreement according to which Medingo was to provided marketing, administration, consultation and support services in exchange for cost + 5%. a manufacturing agreement, under which Medingo was to provide manufacturing and packaging services in exchange for cost + 5. A license agreement was also entered, according to which Roche could now manufacture, use, sell, exploit, continue development and sublicense to related parties the Medingo IP in exchange for 2% of the relevant net revenues. Finally, in 2013, Medingo’s operation in Israel was terminated and its IP sold to Roche for approximately USD 45 million ... Read more
Sweden vs Swedish Match Intellectual Property AB, May 2022, Supreme Administrative Court, Case No Mål: 5264--5267-20, 5269-20

Sweden vs Swedish Match Intellectual Property AB, May 2022, Supreme Administrative Court, Case No Mål: 5264–5267-20, 5269-20

At issue was whether the acquisition value of an inventory acquired from a related company should be adjusted on the basis of Swedish arm’s length provisions or alternatively tax avoidance provisions According to the arm’s length rule in Chapter 18, Section 11 of the Income Tax Act, the acquisition value is to be adjusted to a reasonable extent if the taxpayer or someone closely related to the taxpayer has taken steps to enable the taxpayer to obtain a higher acquisition value than appears reasonable and it can be assumed that this has been done in order to obtain an unjustified tax advantage for one of the taxpayer or someone closely related to the taxpayer. Company (A) acquired a trademark from another company (B) in the same group for a price corresponding to its market value and used the acquisition value as the basis for depreciation deductions totalling approximately SEK 827 million. At B, the tax value of the trademark amounted ... Read more
Sweden vs Flir Commercial Systems AB, January 2022, Administrative Court of Appeal, Case No 2434–2436-20

Sweden vs Flir Commercial Systems AB, January 2022, Administrative Court of Appeal, Case No 2434–2436-20

In 2012, Flir Commercial Systems AB sold intangible assets from a branch in Belgium and subsequently claimed a tax relief of more than SEK 2 billion in fictitious Belgian tax due to the sale. The Swedish Tax Agency decided not to allow relief for the Belgian “tax”, and issued a tax assessment where the relief of approximately SEK 2 billion was denied and a surcharge of approximately SEK 800 million was added. An appeal was filed with the Administrative Court, In March 2020 the Administrative Court concluded that the Swedish Tax Agency was correct in not allowing relief for the fictitious Belgian tax. In the opinion of the Administrative Court, the Double tax agreement prevents Belgium from taxing increases in the value of the assets from the time where the assets were owned in Sweden. Consequently, any fictitious tax cannot be credited in the Swedish taxation of the transfer. The Court also considers that the Swedish Tax Agency was correct ... Read more
TPG2022 Chapter VI Annex I example 23

TPG2022 Chapter VI Annex I example 23

83. Birincil acquires 100% of the equity interests in an independent enterprise, Company T for 100. Company T is a company that engages in research and development and has partially developed several promising technologies but has only minimal sales. The purchase price is justified primarily by the value of the promising, but only partly developed, technologies and by the potential of Company T personnel to develop further new technologies in the future. Birincil’s purchase price allocation performed for accounting purposes with respect to the acquisition attributes 20 of the purchase price to tangible property and identified intangibles, including patents, and 80 to goodwill. 84. Immediately following the acquisition, Birincil causes Company T to transfer all of its rights in developed and partially developed technologies, including patents, trade secrets and technical know-how to Company S, a subsidiary of Birincil. Company S simultaneously enters into a contract research agreement with Company T, pursuant to which the Company T workforce will continue to ... Read more
TPG2022 Chapter VI Annex I example 22

TPG2022 Chapter VI Annex I example 22

78. Company A owns a government licence for a mining activity and a government licence for the exploitation of a railway. The mining licence has a standalone market value of 20. The railway licence has a standalone market value of 10. Company A has no other net assets. 79. Birincil, an entity which is independent of Company A, acquires 100% of the equity interests in Company A for 100. Birincil’s purchase price allocation performed for accounting purposes with respect to the acquisition attributes 20 of the purchase price to the mining licence; 10 to the railway licence; and 70 to goodwill based on the synergies created between the mining and railway licences. 80. Immediately following the acquisition, Birincil causes Company A to transfer its mining and railway licences to Company S, a subsidiary of Birincil. 81. In conducting a transfer pricing analysis of the arm’s length price to be paid by Company S for the transaction with Company A, it ... Read more

TPG2022 Chapter IX paragraph 9.131

In determining which party(ies) should be attributed the location savings at arm’s length, it will be important to consider the functions, risks and assets of the parties, as well as the options realistically available to each of them. In this example, assume that there is a high demand for the type of engineering services that the company in Country X sells. Assume also that the subsidiary in Country Y is the only company operating in a lower-cost location that is able to provide such services with the required quality standard, and Company Y is able to withstand competitive pricing pressures because the technical know-how it has established acts as a barrier to competition. Furthermore, the company in Country X does not have the option of engaging qualified engineers in Country X to provide these services, as the cost of their wages would be too high compared to the hourly rate charged to clients. Considering this, the enterprise in Country X ... Read more

TPG2022 Chapter IX paragraph 9.130

As another example, assume now that an enterprise in Country X provides highly specialised and quality engineering services to independent clients. It charges a fee to its independent clients based on a fixed hourly rate that compares with the hourly rate charged by competitors for similar services in the same market. Suppose that the wages for qualified engineers in Country X are high. The enterprise subsequently subcontracts a large part of its engineering work to a new subsidiary in Country Y. The subsidiary in Country Y hires equally qualified engineers to those in Country X for substantially lower wages, thus deriving significant location savings for the group formed by the enterprise and its subsidiary Clients continue to deal directly with the enterprise in Country X and are not necessarily aware of the sub-contracting arrangement. For some period of time, the well-known enterprise in Country X can continue to charge its services at the original hourly rate despite the significantly reduced ... Read more

TPG2022 Chapter IX paragraph 9.129

In such an example, given that the relocated activity is a highly competitive one, it is likely that the enterprise in Country A has the option realistically available to it to use either the affiliate in Country B or a third party manufacturer. As a consequence, it should be possible to find comparables data to determine the conditions in which a third party would be willing at arm’s length to manufacture the clothes for the enterprise. In such a situation, a contract manufacturer at arm’s length would generally be attributed very little, if any, part of the location savings. Doing otherwise would put the associated manufacturer in a situation different from the situation of an independent manufacturer, and would be contrary to the arm’s length principle ... Read more

TPG2022 Chapter IX paragraph 9.128

Take the example of an enterprise that designs, manufactures and sells brand name clothes. Assume that the manufacturing process is basic and that the brand name is famous and represents a highly valuable intangible. Assume that the enterprise is established in Country A where the labour costs are high and that it decides to close down its manufacturing activities in Country A and to relocate them in an affiliate company in Country B where labour costs are significantly lower. The enterprise in Country A retains the rights on the brand name and continues designing the clothes. Further to this restructuring, the clothes will be manufactured by the affiliate in Country B under a contract manufacturing arrangement. The arrangement does not involve the use of any significant intangible owned by or licensed to the affiliate or the assumption of any significant risks by the affiliate in Country B. Once manufactured by the affiliate in Country B, the clothes will be sold ... Read more

TPG2022 Chapter IX paragraph 9.127

Where significant location savings are derived further to a business restructuring, the question arises of whether and if so how the location savings should be shared among the parties. In addressing this matter, the guidance in Section D.6 of Chapter I is relevant ... Read more

TPG2022 Chapter IX paragraph 9.126

Location savings can be derived by an MNE group that relocates some of its activities to a place where costs (such as labour costs, real estate costs, etc.) are lower than in the location where the activities were initially performed, account being taken of the possible costs involved in the relocation (such as termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees, etc.). Where a business strategy aimed at deriving location savings is put forward as a business reason for restructuring, the discussion in Section D. 1.5 of Chapter I is relevant ... Read more

TPG2022 Chapter IX paragraph 9.125

There will also be cases where before-and-after comparisons can be made because the transactions prior to the restructuring were not controlled, for instance where the restructuring follows an acquisition, and where adjustments can reliably be made to account for the differences between the pre-restructuring uncontrolled transactions and the post-restructuring controlled transactions. See example at paragraph 9.110. Whether such uncontrolled transactions provide reliable comparables would have to be evaluated in light of the guidance at paragraph 3.2 ... Read more

TPG2022 Chapter IX paragraph 9.124

Based on these findings, it can be concluded that Company A continues to perform the same functions and assume the same risks as before the restructuring took place. In particular, Company A continues to have the capability and actually performs control functions in relation to the risk of exploitation of the intangibles. It also carries on the functions related to the development, maintenance and execution of the worldwide marketing strategy. Company Z has no capability to perform control functions, and does not in fact perform the control functions needed to assume the intangible related risks. Accordingly, the accurate delineation of the transaction after the restructuring may lead to the conclusion that this is in substance a funding arrangement between Company A and Company Z, rather than a restructuring for the centralisation of intangible management. An assessment may be necessary of the commercial rationality of the transaction based on the guidance in Section D.2 of Chapter I taking into account the ... Read more

TPG2022 Chapter IX paragraph 9.123

Then a restructuring takes place. Legal ownership of the trademarks, trade names and other intangibles represented by the brand is transferred by Company A to a newly set up affiliate, Company Z in Country Z in exchange for a lump sum payment. After the restructuring, Company A is remunerated on a cost plus basis for the services it performs for Company Z and the rest of the group. The remuneration of the affiliated contract manufacturers and distributors remains the same. The remaining profits after remuneration of the contract manufacturers, distributors, and Company A head office services are paid to Company Z. The accurate delineation of the transactions before and after the restructuring determines that: Company Z is managed by a local trust company. It does not have people (employees or directors) who have the capability to perform, and who in fact do not perform control functions in relation to the risks associated with the ownership or the strategic development of ... Read more

TPG2022 Chapter IX paragraph 9.122

For example, an MNE manufactures and distributes products the value of which is not determined by the technical features of the products, but rather by consumer recognition of the brand. The MNE wants to differentiate itself from its competitors through the development of brands with great value, by implementing a carefully developed and expensive marketing strategy. The trademarks, trade names and other intangibles represented by the brand are owned by Company A in Country A and Company A assumes the risks associated with the ownership, development and exploitation of those intangibles. The development, maintenance and execution of a worldwide marketing strategy are the main value drivers of the MNE, performed by 125 employees at Company A’s head office. The value of the intangibles results in a high consumer price for the products. Company A’s head office also provides central services for the group affiliates (e.g. human resource management, legal, tax). The products are manufactured by affiliates under contract manufacturing arrangements ... Read more

TPG2022 Chapter IX paragraph 9.121

The analysis of the business before and after the restructuring may reveal that while some functions, assets and risks were transferred, other functions may still be carried out by the “stripped” entity. Typically, as part of the restructuring the entity may have been purportedly stripped of intangibles or risk, but after the restructuring it continues to carry out some or all of the functions it previously performed. Following the restructuring, however, the “stripped” entity performs those functions under contract to a foreign associated enterprise. The accurate delineation of the actual transaction between the foreign associated enterprise and the “stripped” entity will determine the actual commercial or financial relations between them, including whether the contractual terms are consistent with the conduct of the parties and other facts of the case. Arm’s length compensation for each party should be consistent with its actual functions performed, assets used and risks assumed after the restructuring ... Read more

TPG2022 Chapter IX paragraph 9.120

That being said, in business restructurings, before-and-after comparisons could play a role in understanding the restructuring itself and could be part of a before-and-after comparability (including functional) analysis to understand the changes that accounted for the changes in the allocation of profit/loss amongst the parties. In effect, information on the arrangements that existed prior to the restructuring and on the conditions of the restructuring itself could be essential to understand the context in which the post-restructuring arrangements were put in place and to assess whether such arrangements are arm’s length. It can also shed light on the options realistically available to the restructured entity. (See paragraphs 9.27-9.31 for a discussion of options realistically available; see also paragraphs 9.102-9.106 for a discussion of possible factual differences between situations that result from a restructuring and situations that were structured as such from the beginning and of how such differences may affect the options realistically available to the parties in negotiating the terms ... Read more

TPG2022 Chapter IX paragraph 9.119

Another issue with before-and-after comparisons is the likely difficulty of valuing the basket of functions, assets and risks that were lost by the restructured entity, keeping in mind that it is not always the case that these functions, assets and risks are transferred to another party ... Read more

TPG2022 Chapter IX paragraph 9.118

One important issue with such before-and-after comparisons is that a comparison of the profits from the post-restructuring controlled transactions with the profits made in controlled transactions prior to the restructuring would not suffice given Article 9 of the OECD Model Tax Convention provides for a comparison to be made with uncontrolled transactions. Comparisons of a taxpayer’s controlled transactions with other controlled transactions are irrelevant to the application of the arm’s length principle and therefore should not be used by a tax administration as the basis for a transfer pricing adjustment or by a taxpayer to support its transfer pricing policy ... Read more

TPG2022 Chapter IX paragraph 9.117

A relevant question is the role if any of comparisons that can be made of the profits actually earned by a party to a controlled transaction prior to and after the restructuring. In particular, it can be asked whether it would be appropriate to determine a restructured entity’s post-restructuring profits by reference to its pre-restructuring profits, adjusted to reflect the transfer or relinquishment of particular functions, assets and risks ... Read more

TPG2022 Chapter IX paragraph 9.116

In other words, in this situation where the taxpayer will have an ongoing business relationship as supplier to the foreign associated enterprise that carries on an activity previously carried on by the taxpayer, the taxpayer and the foreign associated enterprise have the opportunity to obtain economic and commercial benefits through that relationship (e.g. the sale price of goods) which may explain for instance why compensation through an up-front capital payment for transfer of the business was foregone, or why the future transfer price for the products might be different from the prices that would have been agreed absent a restructuring operation. In practice, however, it might be difficult to structure and monitor such an arrangement. While taxpayers are free to choose the form of compensation payments, whether up-front or over time, tax administrations when reviewing such arrangements would want to know how the compensation for the post-restructuring activity was possibly affected to take account of the foregone compensation, if any, ... Read more

TPG2022 Chapter IX paragraph 9.115

Another example would be where a taxpayer that operates a manufacturing and distribution activity restructures by disposing of its distribution activity to a foreign associated enterprise to which the taxpayer will in the future sell the goods it manufactures. The foreign associated enterprise would expect to be able to earn an arm’s length reward for its investment in acquiring and operating the business. In this situation, the taxpayer might agree with the foreign associated enterprise to forgo receipt of part or all of the up-front compensation for the business that may be payable at arm’s length, and instead obtain comparable financial benefit over time through selling its goods to the foreign associated enterprise at prices that are higher than the latter would otherwise agree to if the up-front compensation had been paid. Alternatively, the parties might agree to set an up-front compensation payment for the restructuring that is partly offset through future lower transfer prices for the manufactured products than ... Read more

TPG2022 Chapter IX paragraph 9.114

There may in some circumstances be an important inter-relationship between the compensation for the restructuring and an arm’s length reward for operating the business post-restructuring. This can be the case where a taxpayer disposes of business operations to an associated enterprise with which it must then transact business as part of those operations. One example of such a relationship is found in paragraph 9.74 regarding outsourcing ... Read more

TPG2022 Chapter IX paragraph 9.113

The identification of potential comparables has to be made with the objective of finding the most reliable comparables data in the circumstances of the case, keeping in mind the limitations that may exist in availability of information and the compliance costs involved (see paragraphs 3.2 and 3.80). It is recognised that the data will not always be perfect. There are also cases where comparables data are not found, for instance where the restructuring has led to fragmentation of integrated functions across several group companies in a way that is not found between unrelated parties. This does not necessarily mean that the conditions of the controlled transaction as accurately delineated are not arm’s length. Notwithstanding the difficulties that can arise in the process of searching comparables, it is necessary to find a reasonable solution to all transfer pricing cases. Following the guidance at paragraph 2.2, even in cases where comparables data are scarce and imperfect, the choice of the most appropriate ... Read more

TPG2022 Chapter IX paragraph 9.112

Whenever a comparable is proposed, it is important to ensure that a comparability analysis of the controlled and uncontrolled transactions is performed in order to identify material differences, if any, between them and, where necessary and possible, to adjust for such differences. In particular, the comparability analysis might reveal that the restructured entity continues to perform valuable and significant functions and/or the presence of local intangibles and/or of economically significant risks that remain in the “stripped” entity after the restructuring but are not found in the proposed comparables. See Section A on the possible differences between restructured activities and start-up situations ... Read more

TPG2022 Chapter IX paragraph 9.111

Another example of a possible application of the CUP method would be the case where independent parties provide manufacturing, selling or service activities comparable to the ones provided by the restructured affiliate. Given the recent development of outsourcing activities, it may be possible in some cases to find independent outsourcing transactions that provide a basis for using the CUP method in order to determine the arm’s length remuneration of post-restructuring controlled transactions. This of course is subject to the condition that the outsourcing transactions qualify as uncontrolled transactions and that the review of the five economically relevant characteristics or comparability factors provides sufficient comfort that either no material difference exists between the conditions of the uncontrolled outsourcing transactions and the conditions of the post-restructuring controlled transactions, or that reliable enough adjustments can be made (and are effectively made) to eliminate such differences ... Read more

TPG2022 Chapter IX paragraph 9.110

There are cases where comparables (including internal comparables) are available, subject to possible comparability adjustments being performed. One example of a possible application of the CUP method would be the case where an enterprise that used to transact independently with the MNE group is acquired, and the acquisition is followed by a restructuring of the now controlled transactions. Subject to a review of the five economically relevant characteristics or comparability factors and of the possible effect of the controlled and uncontrolled transactions taking place at different times, it might be the case that the conditions of the pre-acquisition uncontrolled transactions provide a CUP for the post-acquisition controlled transactions. Even where the conditions of the transactions are restructured, it might still be possible, depending on the facts and circumstances of the case, to adjust for the transfer of functions, assets and/or risks that occurred upon the restructuring. For instance, a comparability adjustment might be performed to account for the fact that ... Read more

TPG2022 Chapter IX paragraph 9.109

Post-restructuring arrangements may pose certain challenges with respect to the identification of potential comparables in cases where the restructuring implements a business model that is hardly found between independent enterprises. It should be noted that the mere fact that an arrangement is not seen between independent enterprises does not in itself mean that it is not arm’s length nor commercially irrational. Furthermore, every effort should be made to determine the pricing for the restructuring transactions as accurately delineated under the arm’s length principle ... Read more

TPG2022 Chapter IX paragraph 9.108

The selection and application of a transfer pricing method to post-restructuring controlled transactions must derive from the analysis of the economically relevant characteristics of the controlled transaction as accurately delineated. It is essential to understand what the functions, assets and risks involved in the post-restructuring transactions are, and what party performs, uses or assumes them. This requires information to be available on the functions, assets and risks of both parties to a transaction, e.g. the restructured entity and the foreign associated enterprise with which it transacts. The analysis should go beyond the label assigned to the restructured entity, as an entity that is labelled as a “commissionnaire” or “limited risk distributor” can sometimes be found to own valuable local intangibles and to continue to assume significant market risks, and an entity that is labelled as a “contract manufacturer” can sometimes be found to pursue significant development activities or to own and use unique intangibles. In post-restructuring situations, particular attention should ... Read more

TPG2022 Chapter IX paragraph 9.107

The same remarks and questions apply for other types of restructurings, including other types of restructuring of sales activities as well as restructurings of manufacturing activities, research and development activities, or other services activities ... Read more

TPG2022 Chapter IX paragraph 9.106

Where a restructuring involves a transfer to a foreign associated enterprise of risks that were previously assumed by a taxpayer, it may be important to examine whether the transfer of risks only concerns the future risks that will arise from the post-restructuring activities or also the risks existing at the time of the restructuring as a result of pre-conversion activities, i.e. there is a cut-off issue. For instance, consider a situation in which a distributor was assuming bad debt risks which it will no longer assume after its being restructured as a “limited risk distributor”, and that it is being compared with a long-established “limited risk distributor” that never assumed bad debt risk. It may be important when comparing both situations to examine, based on the guidance in Section D. 1.2.1 of Chapter I, whether the “limited risk distributor” that results from a conversion still assumes the risks associated with bad debts that arose before the restructuring at the time ... Read more

TPG2022 Chapter IX paragraph 9.105

When one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a situation where a limited risk distributor has been in existence in the market for the same duration, there might also be differences because the full-fledged distributor may have performed some functions, borne some expenses (e.g. marketing expenses), assumed some risks and contributed to the development of some intangibles before its conversion that the long-existing “limited risk distributor” may not have performed, borne, assumed or contributed to. The question arises whether at arm’s length such additional functions, assets and risks should only affect the remuneration of the distributor before its being converted, whether they should be taken into account to determine a remuneration of the transfers that take place upon the conversion (and if so how), whether they should affect the remuneration of the restructured limited risk distributor (and if so how), or a combination of these three possibilities. For instance, if ... Read more

TPG2022 Chapter IX paragraph 9.104

Some differences in the starting position of the restructured entity compared to the position of a newly set up operation can relate to the established presence of the operation. For instance, if one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a situation where a limited risk distributor is established in a market where the group did not have any previous commercial presence, market penetration efforts might be needed for the new entrant which are not needed for the converted entity. This may affect the comparability analysis and the determination of the arm’s length remuneration in both situations ... Read more

TPG2022 Chapter IX paragraph 9.103

Where there is an ongoing business relationship between the parties before and after the restructuring, there may also be an inter-relationship between on the one hand the conditions of the pre-restructuring activities and/or of the restructuring itself, and on the other hand the conditions for the post-restructuring arrangements, as discussed in Section C below ... Read more

TPG2022 Chapter IX paragraph 9.102

Where an arrangement between associated enterprises replaces an existing arrangement (restructuring), there may be factual differences in the starting position of the restructured entity compared to the position of a newly set up operation. Sometimes, the post-restructuring arrangement is negotiated between parties that have had prior contractual and commercial relationships. In such a situation, depending on the facts and circumstances of the case and in particular on the rights and obligations derived by the parties from these prior arrangements, this may affect the options realistically available to the parties in negotiating the terms of the new arrangement and therefore the conditions of the restructuring and of the post-restructuring arrangements (see paragraphs 9.27-9.31 for a discussion of options realistically available in the context of determining the arm’s length compensation for the restructuring itself). For instance, assume a party has proved in the past to be able to perform well as a full-fledged distributor performing a whole range of marketing and selling ... Read more

TPG2022 Chapter IX paragraph 9.101

In addition, the comparability analysis of an arrangement that results from a business restructuring might reveal some factual differences compared to the one of an arrangement that was structured as such from the beginning, as discussed below. These factual differences do not affect the arm’s length principle or the way the guidance in these Guidelines should be interpreted and applied, but they may affect the comparability analysis and therefore the outcome of this application. See Section D on comparing the pre- and post-restructuring ... Read more

TPG2022 Chapter IX paragraph 9.100

However, business restructuring situations involve change, and the arm’s length principle must be applied not only to the post-restructuring transactions, but also to additional transactions that comprise the business restructuring. The application of the arm’s length principle to those additional transactions is discussed in Part I of this chapter ... Read more

TPG2022 Chapter IX paragraph 9.99

Comparable situations must be treated in the same way, regardless of whether or not they came into existence as a result of a business restructuring of a previously existing structure. The selection and practical application of an appropriate transfer pricing method must be based on the economically relevant characteristics of the transaction leading to the accurate delineation of the actual transaction ... Read more

TPG2022 Chapter IX paragraph 9.98

The arm’s length principle and these Guidelines do not and should not apply differently to post-restructuring transactions as opposed to transactions that were structured as such from the beginning. Doing otherwise would create a competitive distortion between existing players who restructure their activities and new entrants who implement the same business model without having to restructure their business ... Read more

TPG2022 Chapter IX paragraph 9.97

There can be cases where at arm’s length A and C would be willing to share the indemnification costs. In cases where the benefits arising from the restructuring accrue to another party in the MNE group, then that other party may bear the costs of indemnification, either directly or indirectly ... Read more

TPG2022 Chapter IX paragraph 9.96

There can be situations where C would be willing to pay an up-front fee to obtain the rights to the manufacturing contract from A, e.g. if the present value of the expected profits to be derived from its new manufacturing contract makes it worth the investment for C. In such situations, the payment by C might be organised in a variety of ways, for instance it might be that C would be paying A, or that C would be constructively paying A by meeting A’s indemnification obligation to B. It is also possible that C would pay B, for example, in the circumstances where B had certain rights and C would pay B for the transfer of those rights ... Read more

TPG2022 Chapter IX paragraph 9.95

There can be situations where A would be willing to bear the indemnification costs at arm’s length, for instance because it expects that the termination of its agreement with B will make it possible for it to derive costs savings through its new manufacturing agreement with C, and that the present value of these expected costs savings is greater than the amount of the indemnification ... Read more

TPG2022 Chapter IX paragraph 9.94

Assume a manufacturing contract between two associated enterprises, entity A and entity B, is terminated by A (B being the manufacturer). Assume A decides to use another associated manufacturer, entity C, to continue the manufacturing that was previously performed by B. As noted at paragraph 9.78, there should be no presumption that all contract terminations or substantial renegotiations should give a right to indemnification at arm’s length. Assume that it is determined, based on the guidance in this section, that in the circumstances of the case at arm’s length, B would be in a position to claim an indemnification for the detriment suffered from the termination. The question arises as to which party should ultimately bear the indemnification to be paid to B: A (i.e. the party terminating the contract), C (i.e. the party taking over the manufacturing activity previously performed by B), or another party in the MNE group benefitting from the restructuring. The analysis should start from the ... Read more

TPG2022 Chapter IX paragraph 9.93

The transfer pricing analysis of the arm’s length nature of the conditions of the termination or substantial renegotiation of an agreement should take account of both the perspectives of the transferor and of the transferee. Taking account of the transferee’s perspective is important both to value the amount of an arm’s length indemnification, if any, and to determine what party should bear it. It is not possible to derive a single answer for all cases and the response should be based on an examination of the facts and circumstances of the case, and in particular of the rights and other assets of the parties, of the risks assumed by the parties, of the economic rationale for the termination, of the determination of what party(ies) is (are) expected to benefit from it, and of the options realistically available to the parties. This can be illustrated as follows ... Read more

TPG2022 Chapter IX paragraph 9.92

In the case where the conditions made or imposed between associated enterprises with respect to the termination, non-renewal or substantial renegotiation of their existing arrangements differ from the conditions that would be made between independent enterprises, then any profits that would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly ... Read more

TPG2022 Chapter IX paragraph 9.91

A similar issue may arise in the case where a party has undertaken development efforts resulting in losses or low returns in the early period and above-normal returns are expected in periods following the termination of the contract. In such a case, it will be necessary to analyse the actual arrangements very carefully to determine whether the party in substance takes a stake in the results of the development efforts or has merely accepted deferred payment terms. In performing the analysis the guidance relating to control over risk in Section D. 1.2.1 of Chapter I will be relevant. If the party does control the risks, it might be expected that the party would seek to protect itself from the risk of non-recovery through penalty or indemnification terms. If the party did not control the risks of non-recovery, then the terms are unlikely to be arm’s length ... Read more

TPG2022 Chapter IX paragraph 9.90

As a general matter, mitigation of risk inherent in the investment by a manufacturer is relevant to consider only if the manufacturer assumes the risk. In practice, the investment by an associated enterprise in a manufacturing plant where that enterprise is wholly dependent on another associated enterprise for the capability to generate returns is likely to require careful scrutiny in relation to the identification of risks and how those risks are controlled. As explained in Example 2 in paragraphs 1.84 and 1.102 where significant risks associated with generating a return from the manufacturing activities are controlled solely by another party (which also has the financial capacity to bear that risk), then that other party is allocated the upside and downside consequences of those risks, including under-utilisation, write-down, and closure costs. In that case, the manufacturer should not suffer the financial consequences of an early termination, as it did not control the economically significant risks that contributed to the closure, and ... Read more

TPG2022 Chapter IX paragraph 9.89

At arm’s length, the manufacturer may mitigate the risks inherent in the investment by: Including in the contract an appropriate indemnification clause or penalties in case of early termination, or an option for the party making the investment to transfer it at a given price to the other party in case the investment becomes useless to the former due to the early termination of the contract by the latter. Factoring the risk linked with the possible termination of the contract into the determination of the remuneration of the activities covered by the contract (e.g. by factoring the risk into the determination of the remuneration of the manufacturing activities where third party comparables that bear comparable risks can be identified, perhaps by including front-end loaded fee structures). In such a case the party making the investment consciously accepts the risk and is rewarded for it; no separate indemnification for the termination of the contract seems necessary ... Read more

TPG2022 Chapter IX paragraph 9.88

An example would be where a manufacturing contract between associated enterprises requires the manufacturer to invest in a new manufacturing unit. Assume an arm’s length return on the investment can reasonably be anticipated by the manufacturer at the time the contract is concluded, subject to the manufacturing contract lasting for at least five years, for the manufacturing activity to produce at least x units per year, and for the remuneration of the manufacturing activity to be calculated on a basis (e.g. y$/unit) that is expected to generate an arm’s length return on the total investment in the new manufacturing unit. Assume that after three years, the associated enterprise terminates the contract in accordance with its terms in the context of a group-wide restructuring of the manufacturing operations. Assume the manufacturing unit is highly specialised and the manufacturer further to the termination would have no other choice than to write off the assets ... Read more