Tag: Pre- and Post Restructuring Result

Netherlands vs Zinc Smelter B.V., March 2020, Court of Appeal, Case No ECLI:NL:GHSHE:2020:968

Netherlands vs Zinc Smelter B.V., March 2020, Court of Appeal, Case No ECLI:NL:GHSHE:2020:968

A Dutch company, Zinc Smelter B.V., transferred part of it’s business to a Swiss group company in 2010. In dispute was whether the payment for the transferred activities had been set at arm’s length, and whether the cost-plus remuneration applied to the Dutch company after the business restructuring constituted an arm’s length remuneration for the remaining activities in the company. The case had previously been presented before the lower court where a decision had been issued in October 2017. After hearings in the Court of Appeal, Zinc Smelter B.V. and the Dutch tax authorities reached a settlement which was laid down in the decision. According to the agreement the profit split method was the correct method for determining the arm’s length remuneration of the Dutch company after the restructuring. Click here for English translation ECLI_NL_GHSHE_2020_968 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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, ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case

TPG2017 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 ... Continue to full case