Transfer Pricing Issues in Business Restructurings

Transcription

1 Transfer Pricing Issues in Business Restructurings Mike Murphy December 6, 2008 L E A D E R S H I P P R O B L E M SO L V I N G V A L U E C R E A T I O N

2 Contents Statement of Objective Business Restructurings and the Business Supply Chain Basic and Advanced Transfer Pricing Considerations What Should You Think About in Advance? Illustrations Concluding Comments Objective: Provide a holistic framework describing the potentially complex set of transfer pricing considerations required by business restructurings. 1

3 What Restructurings Are of Interest? Key events may occur that warrant a review of your transfer pricing model. Drivers and events are often interlinked for example the developmen t of a new product leads to potential IP value M&A RELATED Acquire a company Acquire a brand or other IP Outsource manufacturing to a 3 rd party Outsource services (IT, F&A, etc.) to a 3 rd party RESTRUCTURING RELATED Establish internal shared services center (e.g., IT, procurement) Add a new product line; expand into a new geographic market Creation of centres of excellence (e.g., marketing and sales, etc.) Centralize regional management Develop new products (R&D), services, or other IP (e.g., software) Revise business model (e.g., migrate to internet based) Business reorganization directed at cost cutting/rationalize production 2 2

4 Restructurings Can Affect Multiple Parts of Supply Chain S U P P L I E R S Plan Buy Make Move Sell Planning & Forecasting R&D and Product Design Procurement & Logistics Manufacturing Transportation Distribution & Logistics Marketing, Order Management, Service and Support C U S T O M E R S The supply chain mapping is complemented by other analyses to complete the description understanding of the enterprise: transactions flows (legal, cash, physical, process) value chain/economics functional analysis legal & organizational structures 3

5 Transfer Pricing Considerations - Basic Issues: Intercompany sales of parts, components, finished products and other tangible goods Intercompany payments for services Licenses of IP ( software, patents, designs, know how, business procedures, etc.) Interest rates on loans Performance and financial guarantees Compliance needs policies, reports, and intercompany agreements Important to avoid tax audit risks But there is more to consider 4

6 Transfer Pricing Considerations - Advanced EFFECTIVE TAX RATE MANAGEMENT COMPLIANCE & DOCUMENTATION CASH MGMNT & REPATRIATION ACCOUNTING REQUIREMENTS MAXIMIZE SHAREHOLDER VALUE IT SYSTEMS & BUSINESS PROCEDURES PE ISSUES, INDIRECT TAXES, INCENTIVES 5

7 Determinants of Global ETR Algebra behind global ETR determination Value adding activities and profits Location and the tax rates effective in those jurisdictions Credits and NOLs Key role of location IP domicile Manufacturing Other supply chain components Debt internal and external Legal structuring and allocation of risks is the foundation Transfer pricing ties it all together 6

8 Transfer Pricing Considerations Before Restructuring Location considerations Business operation requirements will be key driver Understand the implications of the location decision IP special considerations Always consider platform for future growth Exit costs can be significant for later changes Legal structuring affects allocation of risks and rewards/losses within the group Affects all aspects of the business supply chain Requires alignment of business operations and economic substance Ultimately driven by business operation requirements Exit costs can be significant for later changes 7 Transfer pricing ties it all together

9 Legal Structuring Illustration Sales Channel BUY-SELL (FULL-FUNCTION OR PURE) DISTRIBUTOR Distributes at highest level of market (i.e. to full-function distributors) Can be responsible for development of marketing and/or design intangibles Holds inventory, Sales force, warehousing LIMITED RISK DISTRIBUTOR Limited inventory, credit, warranty or specific risk Sales force; No significant intangibles COMMISSIONAIRE (CIVIL LAW AGENT) Sells in own name for the risk & account of undisclosed principal Regulated by Civil Law Code No inventory, credit, warranty or specific risks Sales force; No significant intangibles Identifies buyer; Acts as intermediary AGENT (COMMON & CIVIL LAW) As Commissionaire but regulated only by contract and applicable commercial law Marketing Representative responsible for marketing and order Solicitation only 8 DIRECT SALE Sold direct from principal, no sales intermediary Usually ebusiness sale

10 Legal Structuring Illustration Manufacturing FULL OR PURE MANUFACTURER Sources raw and intermediate materials for its own risk and account and therefore has inventory risk Often holds intangible assets (such as process know-how and developed technology) and performs R&D activities for its own risk and account. Manufacturing is often combined with distribution activity such that the same entity holds sales force and performs sales and marketing and therefore has credit and other specific risks. A combined manufacturer-distributor generally has product and market risk CONTRACT MANUFACTURER A contract manufacturer is a manufacturing services provider Source raw materials and is a secured source of finished goods supply for one or more principals Has very limited inventory risk Has no or few production/technology intangibles Normally separated from sales & marketing and therefore has no credit risk CONSIGNMENT MANUFACTURER As contract manufacturer, but principal is the source of supply for significantly all raw materials Has no inventory, credit, warranty or other specific risks. Holds no intangible assets 9

11 Legal Structuring Illustration Procurement DIRECT PURCHASE FROM SUPPLIERS Operating companies contract with and are directly supplied by supplying entities PURCHASE THROUGH GROUP SOURCING COMPANY Direct supplies and invoices from suppliers to operating companies Pricing/contract terms negotiated by sourcing company Service fee paid to sourcing company PURCHASE FROM GROUP SOURCING COMPANY Operating companies contract with and are directly supplied by sourcing company Sourcing company contract with/purchases from suppliers 10

12 Legal Structuring Illustration Regional HQ The following are variations of a BU model I Management II Management IP Service Company Planning III Management IP IV Management IP Sales & Distribution Sales & Distribution Procurement Trading Company Planning V Central Entrepreneur company model 11

13 Legal Structuring Illustration Regional HQ IV V HQ Profitability III II I Complexity / Implementation Difficulty 12

14 Legal Structuring Illustration Central Entrepreneur 3P RM Vendors Raw Materials Purchases Parent Company Country1 plant operations (toll manufacturer) Regional Central Entrepreneur company Manufacturing Service Contracts (cost-plus) Customers Sales to customers Country2 plant operations (toll manufacturer) Concept: Structure plant operations as toll manufacturers Key components The Central Entrepreneur company acts as a a self contained company that contracts manufacturing services from the operational sites as if they were 3 rd parties. Has IP rights, manages certain aspects of operations Country4 Raw materials supplier Country3 plant operations (toll manufacturer) 13

15 Legal Structuring Illustration Central Entrepreneur Includes HQ, IP, S&D, and Procurement from Concepts I, II, III, and IV, plus: CE makes sales to 3rd party customers CE owns raw materials, goods in process, goods in transit CE engages the plants as toll manufacturers. As toll manufacturers, the mills are paid a service fee for their services CE would play a role and have substance requirements in scheduling production Central Entrepreneur ( CE ) model would require significant IT systems support since the CE would own inventory and sell to 3rd parties; product cost may be built up at the CE also The toll manufacturer service fee is typically structured on cost plus basis where the cost base includes plant labor, depreciation, and operating costs and expenses Has significant ETR implications Has significant cash management/repatriation implications Has significant indirect tax and customs implications Has significant operational considerations 14

16 Integrating Transfer Pricing Planning Implications Actual Tax only Supply chain only SC / Tax Integration Revenue After-Tax Profit Profit Improvement Tax Pre-Tax Profit Supply chain costs (including materials) Cost Improvement Duties Admin & other costs ETR 40% 34% 40% 30% Profit Improvement (over actual after-tax profit) +10% +40% +87% tax planning constrained by existing operational structures 40% of the savings go to tax authorities supply chain and tax savings - jointly optimized 15

17 Concluding Comments Transfer pricing issues in business restructurings are often viewed as relating only to basic compliance considerations Business restructurings, however, provide circumstances under which companies need to consider their future operations and platform for growth Need to have a vision and game plan for the future and transfer pricing model to support 16

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