Tag: Delineation of Business Restructurings

TPG2022 Chapter IX paragraph 9.33

As part of their transfer pricing documentation, MNE groups are recommended to document their decisions and intentions regarding business restructurings, especially as regards their decisions to assume or transfer significant risks, before the relevant transactions occur, and to document the evaluation of the consequences on profit potential of significant risk allocations resulting from the restructuring. In describing the assumption of risk as part of a business restructuring, it is recommended that taxpayers use the framework set out in Section D. 1.2.1 of Chapter I ... Read more

TPG2022 Chapter IX paragraph 9.32

In the master file (see Annex I to Chapter V), taxpayers are asked to describe any important business restructuring transactions occurring during the year. In addition, in the local file, taxpayers are asked to indicate whether the local entity has been involved in or affected by business restructurings occurring during the year or immediately past year and to explain the aspects of such transactions affecting the local entity (see Annex II to Chapter V) ... Read more

TPG2022 Chapter IX paragraph 9.31

The reference to the notion of options realistically available is not intended to create a requirement for taxpayers to document all possible hypothetical options realistically available. Rather, the intention is to provide an indication that, if there is a realistically available option that is clearly more attractive, it should be considered in the analysis of the conditions of the restructuring ... Read more

TPG2022 Chapter IX paragraph 9.30

At arm’s length, there are also situations where an entity would have had one or more options realistically available to it that would clearly offer more attractive opportunities to meet their objectives than to accept the conditions of the restructuring (taking into account all the relevant conditions, including the commercial and market conditions going forward, the profit potential of the various options and any compensation or indemnification for the restructuring), including possibly the option not to enter into the restructuring transaction. In such cases, an independent party may not have agreed to the conditions of the restructuring and adjustments to the conditions made or imposed may be necessary ... Read more

TPG2022 Chapter IX paragraph 9.29

At arm’s length, there are situations where the restructured entity would have had no clearly more attractive option realistically available to it than to accept the conditions of the restructuring, e.g. a contract termination – with or without indemnification as discussed at Section F below. In longer-term contracts, this may occur by invoking an exit clause that allows for one party to prematurely exit the contract with just cause. In contracts that allow either party to opt out of the contract, the party terminating the arrangement may choose to do so because it has determined, subject to the terms of the termination clause, that it is more favourable to stop using the function, or to internalise it, or to engage a cheaper or more efficient provider or to seek more lucrative opportunities. If the restructured entity transfers rights or other assets or an ongoing concern to another party, it might however be compensated for such a transfer as discussed in ... Read more

TPG2022 Chapter IX paragraph 9.28

Thus, in applying the arm’s length principle, the tax administration should evaluate each transaction as accurately delineated under the guidance in Section D of Chapter I and consider the economically relevant characteristics taken into account by the parties in reaching the conclusion that there is no option realistically available that offers a clearly more attractive opportunity to meet their commercial objectives than the restructuring adopted (see paragraph 1.38). In making such assessment, it may be necessary or useful to assess the transactions comprising the business restructuring in the context of a broader arrangement of economically related transactions ... Read more

TPG2022 Chapter IX paragraph 9.27

The arm’s length principle is based on the notion that independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that offers a clearly more attractive opportunity to meet their commercial objective. In other words, independent enterprises would only enter into a transaction if it does not make them worse off than their next best option. Consideration of the other options realistically available may be relevant to comparability analysis, to understand the respective positions of the parties ... Read more

TPG2022 Chapter IX paragraph 9.26

The fact that a business restructuring may be motivated by anticipated synergies does not necessarily mean that the profits of the MNE group will effectively increase after the restructuring. It may be the case that enhanced synergies make it possible for the MNE group to derive additional profits compared to what the situation would have been in the future if the restructuring had not taken place, but there may not necessarily be additional profits compared to the pre-restructuring situation, for instance if the restructuring is needed to maintain competitiveness rather than to increase it. In addition, expected synergies do not always materialise – there can be cases where the implementation of a global business model designed to derive more group synergies in fact leads to additional costs and less efficiency ... Read more

TPG2022 Chapter IX paragraph 9.25

For example, a business restructuring may involve the setting up by an MNE group of a central procurement operation that replaces the procurement activities of several associated enterprises. Similar to the guidance at paragraph 1.180 the MNE group has taken affirmative steps to centralise purchasing in a single group company to take advantage of volume discounts and potential savings in administrative costs. In accordance with the guidance in Chapter I, the benefits due to deliberate concerted group action should be allocated to the associated enterprises whose contributions create the synergies. However, in a business restructuring, the central procurement company may also contractually assume risk associated with buying, holding, and on-selling goods. As stated in the previous section, an analysis of risk under the framework provided in Section D. 1.2.1 of Chapter I will determine the economic significance of the risk and which party or parties assume that risk. Although the central procurement operation is entitled to profit potential arising from ... Read more

TPG2022 Chapter IX paragraph 9.24

Some businesses have indicated that multinational businesses, regardless of their products or sectors, have reorganised their structures to provide more centralised control and management of manufacturing, research and distribution functions. The pressure of competition in a globalised economy, savings from economies of scale, the need for specialisation and the need to increase efficiency and lower costs have all been described as important in driving business restructurings. Where anticipated synergies are put forward by a taxpayer as an important business reason for the restructuring, it would be a good practice for the taxpayer to document, at the time the restructuring is decided upon or implemented, what these anticipated synergies are and on what assumptions they are anticipated. This is a type of documentation that is likely to be produced at the group level for non-tax purposes, to support the decision-making process of the restructuring. For Article 9 purposes, it would be a good practice for the taxpayer to document the source ... Read more

TPG2022 Chapter IX paragraph 9.23

For instance, where a full-fledged distributor is converted into a limited-risk distributor or commissionnaire resulting in the reduction or elimination of risks relating to inventory in the restructured enterprise, in order to determine whether such risk is economically significant the tax administration may want to analyse: The role of inventory in the business model (for example, speed to market, comprehensive range), The nature of the inventory (for example, spare parts, fresh flowers), The level of investment in inventory, The factors giving rise to inventory write-downs or obsolescence (for example, perishability, pricing pressures, speed of technical improvements, market conditions), The history of write-down and stock obsolescence, and whether any commercial changes affect the reliability of historic performance as an indicator of current risk, The cost of insuring against damage or loss of inventory, and The history of damage or loss (if uninsured) ... Read more

TPG2022 Chapter IX paragraph 9.22

In any analysis of risks in controlled transactions, one important issue is to assess whether a risk is economically significant, i.e. it carries significant profit potential, and, as a consequence, whether that risk may explain a significant reallocation of profit potential. The significance of a risk will depend on the likelihood of the risk materialising and the size of the potential profits or losses arising from the risk. Accounting statements may provide useful information on the probability and quantum of certain risks (e.g. bad debt risks, inventory risks), if past performance is an indicator of current risks, but there are also economically significant risks that may not be separately recorded as such in the financial accounts (e.g. market risks). If a risk is assessed to be economically insignificant for the entity, then that risk would not explain a substantial amount of the entity’s profit potential. At arm’s length a party would not be expected to lay off a risk that ... Read more

TPG2022 Chapter IX paragraph 9.21

A second example relates to the purported transfer of credit risk as part of a business restructuring. The analysis under Section D. 1.2.1 of Chapter I would take into account the contractual terms before and after the restructuring, but would also examine how the parties operate in relation to the risk before and after the restructuring. The analysis would then examine whether the party that contractually assumes the risk controls the risk in practice through relevant capability and decision-making as defined in paragraph 1.65 and has the financial capacity to assume such risk as defined in paragraph 1.64. It is important to note that a party that before the restructuring did not assume a risk under the analysis of Section D. 1.2.1 of Chapter I cannot transfer it to another party, and a party that after the restructuring does not assume a risk under the analysis of Section D. 1.2.1 of Chapter I should not be allocated the profit potential ... Read more

TPG2022 Chapter IX paragraph 9.20

The framework and detailed guidance for analysing risk laid out in Section D. 1.2.1 of Chapter I is applicable for purposes of undertaking an analysis of risks in the context of business restructurings, and in particular for determining which party assumes a specific risk by reference to control and financial capacity. It is crucial to apply this framework to determine which party assumes specific risks before the restructuring and which party assumes specific risks following the restructuring. For example, where a restructuring purports to transfer inventory risk, it is relevant to examine not only the contractual terms, but also the conduct of the parties under Step 3 in the framework (e.g. where any inventory write-downs are taken before and after the restructuring, whether there is any indemnification for those inventory write-downs, which party or parties perform risk control functions and have the financial capacity to assume the risks). The results of this analysis may establish that before the restructuring one ... Read more

TPG2022 Chapter IX paragraph 9.19

Risks are of critical importance in the context of business restructurings. Usually, in the open market, the assumption of risk associated with a commercial opportunity affects the profit potential of that opportunity, and the allocation of risk assumed between the parties to the arrangement affects how profits or losses resulting from the transaction are allocated through the arm’s length pricing of the transaction. Business restructurings often result in local operations being converted into low risk operations (e.g. “low risk distributors”, or “low risk contract manufacturers”) and being remunerated with a relatively low (but generally stable) return on the grounds that the economically significant risks are assumed by another party to which the profits or losses associated with those risks are allocated. For this reason, an examination of the allocation of risks between associated enterprises before and after the restructuring is an essential part of the functional analysis. Such analysis should allow tax administrations to assess the transfer of the economically ... Read more

TPG2017 Chapter IX paragraph 9.33

As part of their transfer pricing documentation, MNE groups are recommended to document their decisions and intentions regarding business restructurings, especially as regards their decisions to assume or transfer significant risks, before the relevant transactions occur, and to document the evaluation of the consequences on profit potential of significant risk allocations resulting from the restructuring. In describing the assumption of risk as part of a business restructuring, it is recommended that taxpayers use the framework set out in Section D. 1.2.1 of Chapter I ... Read more

TPG2017 Chapter IX paragraph 9.32

In the master file (see Annex I to Chapter V), taxpayers are asked to describe any important business restructuring transactions occurring during the year. In addition, in the local file, taxpayers are asked to indicate whether the local entity has been involved in or affected by business restructurings occurring during the year or immediately past year and to explain the aspects of such transactions affecting the local entity (see Annex II to Chapter V) ... Read more

TPG2017 Chapter IX paragraph 9.31

The reference to the notion of options realistically available is not intended to create a requirement for taxpayers to document all possible hypothetical options realistically available. Rather, the intention is to provide an indication that, if there is a realistically available option that is clearly more attractive, it should be considered in the analysis of the conditions of the restructuring ... Read more

TPG2017 Chapter IX paragraph 9.30

At arm’s length, there are also situations where an entity would have had one or more options realistically available to it that would clearly offer more attractive opportunities to meet their objectives than to accept the conditions of the restructuring (taking into account all the relevant conditions, including the commercial and market conditions going forward, the profit potential of the various options and any compensation or indemnification for the restructuring), including possibly the option not to enter into the restructuring transaction. In such cases, an independent party may not have agreed to the conditions of the restructuring and adjustments to the conditions made or imposed may be necessary ... Read more

TPG2017 Chapter IX paragraph 9.29

At arm’s length, there are situations where the restructured entity would have had no clearly more attractive option realistically available to it than to accept the conditions of the restructuring, e.g. a contract termination – with or without indemnification as discussed at Section F below. In longer-term contracts, this may occur by invoking an exit clause that allows for one party to prematurely exit the contract with just cause. In contracts that allow either party to opt out of the contract, the party terminating the arrangement may choose to do so because it has determined, subject to the terms of the termination clause, that it is more favourable to stop using the function, or to internalise it, or to engage a cheaper or more efficient provider or to seek more lucrative opportunities. If the restructured entity transfers rights or other assets or an ongoing concern to another party, it might however be compensated for such a transfer as discussed in ... Read more

TPG2017 Chapter IX paragraph 9.28

Thus, in applying the arm’s length principle, the tax administration should evaluate each transaction as accurately delineated under the guidance in Section D of Chapter I and consider the economically relevant characteristics taken into account by the parties in reaching the conclusion that there is no option realistically available that offers a clearly more attractive opportunity to meet their commercial objectives than the restructuring adopted (see paragraph 1.38). In making such assessment, it may be necessary or useful to assess the transactions comprising the business restructuring in the context of a broader arrangement of economically related transactions ... Read more

TPG2017 Chapter IX paragraph 9.27

The arm’s length principle is based on the notion that independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that offers a clearly more attractive opportunity to meet their commercial objective. In other words, independent enterprises would only enter into a transaction if it does not make them worse off than their next best option. Consideration of the other options realistically available may be relevant to comparability analysis, to understand the respective positions of the parties ... Read more

TPG2017 Chapter IX paragraph 9.26

The fact that a business restructuring may be motivated by anticipated synergies does not necessarily mean that the profits of the MNE group will effectively increase after the restructuring. It may be the case that enhanced synergies make it possible for the MNE group to derive additional profits compared to what the situation would have been in the future if the restructuring had not taken place, but there may not necessarily be additional profits compared to the pre-restructuring situation, for instance if the restructuring is needed to maintain competitiveness rather than to increase it. In addition, expected synergies do not always materialise – there can be cases where the implementation of a global business model designed to derive more group synergies in fact leads to additional costs and less efficiency ... Read more

TPG2017 Chapter IX paragraph 9.25

For example, a business restructuring may involve the setting up by an MNE group of a central procurement operation that replaces the procurement activities of several associated enterprises. Similar to the guidance at paragraph 1.160 the MNE group has taken affirmative steps to centralise purchasing in a single group company to take advantage of volume discounts and potential savings in administrative costs. In accordance with the guidance in Chapter I, the benefits due to deliberate concerted group action should be allocated to the associated enterprises whose contributions create the synergies. However, in a business restructuring, the central procurement company may also contractually assume risk associated with buying, holding, and on-selling goods. As stated in the previous section, an analysis of risk under the framework provided in Section D. 1.2.1 of Chapter I will determine the economic significance of the risk and which party or parties assume that risk. Although the central procurement operation is entitled to profit potential arising from ... Read more

TPG2017 Chapter IX paragraph 9.24

Some businesses have indicated that multinational businesses, regardless of their products or sectors, have reorganised their structures to provide more centralised control and management of manufacturing, research and distribution functions. The pressure of competition in a globalised economy, savings from economies of scale, the need for specialisation and the need to increase efficiency and lower costs have all been described as important in driving business restructurings. Where anticipated synergies are put forward by a taxpayer as an important business reason for the restructuring, it would be a good practice for the taxpayer to document, at the time the restructuring is decided upon or implemented, what these anticipated synergies are and on what assumptions they are anticipated. This is a type of documentation that is likely to be produced at the group level for non-tax purposes, to support the decision-making process of the restructuring. For Article 9 purposes, it would be a good practice for the taxpayer to document the source ... Read more

TPG2017 Chapter IX paragraph 9.23

For instance, where a full-fledged distributor is converted into a limited-risk distributor or commissionnaire resulting in the reduction or elimination of risks relating to inventory in the restructured enterprise, in order to determine whether such risk is economically significant the tax administration may want to analyse: The role of inventory in the business model (for example, speed to market, comprehensive range), The nature of the inventory (for example, spare parts, fresh flowers), The level of investment in inventory, The factors giving rise to inventory write-downs or obsolescence (for example, perishability, pricing pressures, speed of technical improvements, market conditions), The history of write-down and stock obsolescence, and whether any commercial changes affect the reliability of historic performance as an indicator of current risk, The cost of insuring against damage or loss of inventory, and The history of damage or loss (if uninsured) ... Read more

TPG2017 Chapter IX paragraph 9.22

In any analysis of risks in controlled transactions, one important issue is to assess whether a risk is economically significant, i.e. it carries significant profit potential, and, as a consequence, whether that risk may explain a significant reallocation of profit potential. The significance of a risk will depend on the likelihood of the risk materialising and the size of the potential profits or losses arising from the risk. Accounting statements may provide useful information on the probability and quantum of certain risks (e.g. bad debt risks, inventory risks), if past performance is an indicator of current risks, but there are also economically significant risks that may not be separately recorded as such in the financial accounts (e.g. market risks). If a risk is assessed to be economically insignificant for the entity, then that risk would not explain a substantial amount of the entity’s profit potential. At arm’s length a party would not be expected to lay off a risk that ... Read more

TPG2017 Chapter IX paragraph 9.21

A second example relates to the purported transfer of credit risk as part of a business restructuring. The analysis under Section D. 1.2.1 of Chapter I would take into account the contractual terms before and after the restructuring, but would also examine how the parties operate in relation to the risk before and after the restructuring. The analysis would then examine whether the party that contractually assumes the risk controls the risk in practice through relevant capability and decision-making as defined in paragraph 1.65 and has the financial capacity to assume such risk as defined in paragraph 1.64. It is important to note that a party that before the restructuring did not assume a risk under the analysis of Section D. 1.2.1 of Chapter I cannot transfer it to another party, and a party that after the restructuring does not assume a risk under the analysis of Section D. 1.2.1 of Chapter I should not be allocated the profit potential ... Read more

TPG2017 Chapter IX paragraph 9.20

The framework and detailed guidance for analysing risk laid out in Section D. 1.2.1 of Chapter I is applicable for purposes of undertaking an analysis of risks in the context of business restructurings, and in particular for determining which party assumes a specific risk by reference to control and financial capacity. It is crucial to apply this framework to determine which party assumes specific risks before the restructuring and which party assumes specific risks following the restructuring. For example, where a restructuring purports to transfer inventory risk, it is relevant to examine not only the contractual terms, but also the conduct of the parties under Step 3 in the framework (e.g. where any inventory write-downs are taken before and after the restructuring, whether there is any indemnification for those inventory write-downs, which party or parties perform risk control functions and have the financial capacity to assume the risks). The results of this analysis may establish that before the restructuring one ... Read more

TPG2017 Chapter IX paragraph 9.19

Risks are of critical importance in the context of business restructurings. Usually, in the open market, the assumption of risk associated with a commercial opportunity affects the profit potential of that opportunity, and the allocation of risk assumed between the parties to the arrangement affects how profits or losses resulting from the transaction are allocated through the arm’s length pricing of the transaction. Business restructurings often result in local operations being converted into low risk operations (e.g. “low risk distributors”, or “low risk contract manufacturers”) and being remunerated with a relatively low (but generally stable) return on the grounds that the economically significant risks are assumed by another party to which the profits or losses associated with those risks are allocated. For this reason, an examination of the allocation of risks between associated enterprises before and after the restructuring is an essential part of the functional analysis. Such analysis should allow tax administrations to assess the transfer of the economically ... Read more