Transfer Pricing and Customs Valuation Value Added Taxes ICPA

Transfer Pricing and Customs Valuation/Value Added Taxes ICPA EU/UK Conference Rome, Italy June 6, 2016 Christina Rinne Darrel Pearson

Introductory Remarks • Transfer pricing has traditionally been considered an income tax matter, but increasing border enforcement means that customs/VAT requirements must also be considered • Related party transactions are increasingly scrutinized by customs authorities • Transfer pricing models are usually driven by corporate income tax objectives • Income tax-driven pricing models are not sufficient for compliance with customs valuation/VAT • The challenge is to develop a unified approach for income tax and customs/VAT that complies with the different requirements in all countries where your company is doing business 2

Agenda 1. Basic Concepts of Transfer Pricing and Customs Valuation/VAT 2. Tensions between Transfer Pricing and Customs Valuation/VAT 3. Key Issues in TP/Customs Valuation and Case Experiences (EU, Canada, & US) a) Arm’s Length Pricing and Contemporaneous Documentation b) TP Adjustments 4. Best Practices for Customs Compliance Managers and In-House Counsel 3

1. Basic Concepts: Transfer Pricing and Income Tax Objectives • Transfer prices establish the prices charged in cross-border transactions between multinational corporations Ø Transfers of goods, services, and intellectual property • For income (direct) tax purposes, transfer prices are important because they determine the amount of taxable income earned in each jurisdiction • Arm's length principles apply based on OECD Transfer Pricing Guidelines and domestic law/policies • Direct tax authorities focus on potential overvaluation of intercompany transactions 4

1. Basic Concepts: Customs Valuation/VAT • Customs value serves as the base for the application of customs duties/VAT - - - • Many countries have VAT in addition to applicable customs duties (but not US) Canadian imports are subject to a 5% GST (calculated on the customs duty-paid value), but GST registrants can recover the amount paid at the time of import by claiming “input tax credits” European imports are subject to import VAT between 5 and 27 % depending on the Member State’s legislation in which the importation takes place (calculated on the customs duty-paid value); Import VAT is generally deductible as input VAT (depending on the status of the Importer of Record) Swiss imports are subject to import VAT at a rate of 2. 5% or 8 % (calculated on the customs duty-paid value); Import VAT is generally deductible as input VAT (depending on the status of the Importer of Record) Swiss CV differs from the determination of the duty based on the value of the goods: it refers to the weight of the goods EU, Canadian and US rules for establishing customs value are based on the methods set out in the WCO Customs Valuation Code - Transaction value is the primary method of customs valuation Transaction Value (TV) = Price Paid or Payable (PPP) ± adjustments 5

1. Basic Concepts: Customs Valuation/VAT Transfer pricing for customs valuation/VAT is important for multinationals who engage in crossborder trade of goods, services, and intangibles • - - Use of TV is conditioned on the importer being able to demonstrate that the relationship had no effect on the selling price (arm’s length principle) o Basic principle is the same in EU, Canada, and US, but different approaches to establishing arm’s length prices, contemporaneous documentation, and enforcement Consequence of non-arm’s length price is the use of an alternative valuation method (Identical or similar goods, deductive value, computed value, residual value) Alternative methods are more complicated to apply and often result in higher values for duty (and therefore more customs duties and VAT/GST) EU VAT Valuation • - Member States can require substitution of open market valuation where supplier/ recipient are connected and relevant party does not have full right of deduction Private use of business goods 4 6

1. Basic Concepts: Customs Valuation/VAT • • • TP developed for income tax purposes will be different than the PPP ± adjustments PPP is a legally defined term that can vary among jurisdictions Certain costs - included in TP may be deducted from PPP (e. g. , import duties/VAT, transportation to the place of direct shipment, certain costs incurred after importation) - not included in the TP must be added to PPP (e. g. , R&D, certain royalties/license fees and subsequent proceeds (service fees and the like)) Different interpretations to additions/deductions – e. g. , Canada vs. EU vs. US approach to dutiability of royalties Transfer pricing practices for services and intangibles that do not meet customs requirements may result in their inclusion in the dutiable of value of the imported goods - Unbundling 7

2. Tensions between Transfer Pricing and Customs Valuation/VAT • Competing Objectives - Inverse impact of higher TP • Different Methods for Establishing Arm's Length TP - Tax - OECD Guidelines, BEPS Action Plan (Action 8 - 10) , and domestic rules - Customs - TV is preferred method followed by sequential application of alternate methods - Required adjustments to PPP for customs generally do not apply to transfer price for income tax purposes - Transfer price studies for income tax purposes are not determinative of the acceptability of transfer prices for Canadian/US/EU customs (but not for Swiss Customs) - New WCO Guideline (Case Study 14. 1) encourages acceptance of TP studies based on OECD Guidelines – Describes use of a TP study based on TNMM to establish lack of influence - Not binding on customs authorities 8

2. Tensions between Transfer Pricing and Customs Valuation/VAT • Timing Issues - Income tax is periodic - Annual contemporaneous documentation and periodic “true-ups” - Customs is transactional for EU/Swiss, Canada, and US o Contemporaneous documentation for each transaction at time of importation and transaction-based corrections o Post-importation corrections processes vary among EU, Canada, and US (and among EU member states) • Income Tax vs. Customs Approach to Unbundling - Transfer prices should be "unbundled" for customs/VAT purposes (i. e. , goods should be priced separately from non-dutiable payments such as royalties, services, etc. ) - Bundling may result in the requirement to include otherwise non-dutiable costs in the value for duty (e. g. , royalties) 9

3 a. Arm’s Length Pricing and Contemporaneous Documentation General • Transfer pricing documentation typically covers, quite extensively, the economic context (industry and taxpayer’s), a description of the controlled transaction (terms and conditions), an explanation of the choice and application of the transfer pricing method, the comparability analysis (including data on uncontrolled transactions that are used as comparables) • Tax authorities have access to information through domestic provisions (general tax audit provisions, specific transfer pricing documentation requirements) and bilateral treaties (exchange of information) 10

3 a. Arm’s Length Pricing and Contemporaneous Documentation in the EU • EU Tax Authorities challenge TP arrangements where they do not recognize profits correctly attributable to the economic activity in their jurisdiction, in accordance with the rules. - TP documentation consists of a mixture of records and other information in relation to a period covered by a tax return, and may be created at various times. This variety affects the exposure of a business to the risk of a penalty in relation to documentation: o Primary accounting records: records of transactions occurring in the course of the activities of a business that the business enters in its accounting system. These records include the results (in terms of value) of the relevant transactions. In the context of TP rules, these are the “actual” results. They may or may not be “arm’s length” results. o Tax adjustment records: records that identify adjustments made by a business on account of tax rules in order to move from profits in accounts to taxable profits, including the value of those adjustments. o Records of transactions with associated businesses: records in which a business identifies transactions to which TP rules apply. • On 17 June 2015, the EU Commission communicated its Action Plan for a fairer corporate tax system in the European Union - • • by improving the TP framework in the EU, to ensure the taxation of intra-group profits is more fairly linked to the place of activity OECD/G 20 BEPS Action Plan (Action 13) envisages development of a Masterfile/local file approach for TP documentation Structure and contents shall reflect to a very large degree the Code of Conduct on TP documentation in the EU 11

3 a. Arm’s Length Pricing and Contemporaneous Documentation in Switzerland - - The Swiss Tax Authorities generally follow OECD TP Guidelines Specific regulations have been issued on services and debt/ equity ratio Under the prevailing laws, a taxpayer must be in a position to demonstrate, upon request, the arm’s length nature of a related party transaction Increasingly, Cantonal Tax Authorities request TP documentation. Although no specific format is described, it is advisable to prepare adequate documentation especially if the taxpayer changes its business model, incurs high royalty charges or engages in transaction with low-tax – jurisdictions and offshore entities Lack of documentation my result in lengthy tax audits 12

3 a. Arm’s Length Pricing and Contemporaneous Documentation – Canada and US • • Two alternatives for establishing lack of influence in Canada – (1) Demonstrating that the relationship did not influence the price, or (2) demonstrating that TV meets test values (TVI, TVS, Deductive Value, Computed Value) • Most common method is demonstrating lack of influence with a TP study that meets OECD guidelines that is sufficiently granular for customs purposes • Separation of goods from services, IP, and other payments • TP study alone is not enough - Must be supported by all applicable customs, accounting, and tax documents in audit (e. g. , Jockey Canada case example) Similar approach in US – “circumstances of sale” test and test values • Most common method is “circumstances of sale”, which requires that the importer show: • Price was settled in manner consistent with normal pricing practices of industry, • Price was settled in manner consistent with the way seller settles prices for sales to unrelated buyers, or • Price is adequate to ensure recovery of all costs plus profit • TP study may contain relevant information, but the burden is on the importer to submit additional documents to explain why conclusions in TP study should be accepted for customs purposes • US customs policy states that circumstances of sale claim will be rejected if the importer simply submits a TP study without further explanation or supporting documents 13

3 b. Transfer Pricing Adjustments – General • • • Tax implications Local country rules regarding year-end adjustments can vary considerably. Many tax authorities may view year-end adjustments as an examination trigger Some tax authorities view adjustments as non-deductible voluntary contribution or distribution of capital which results in double-taxation issues Customs implications WTO Valuation Agreement does not specifically provide for the treatment of adjustments to transactional value; national legislation will determine the behaviour of respective customs authorities Where possible contact to the customs authorities should be sought in advance (apply for a customs ruling) Customs Authorities tend to view year-end adjustments as directly applicable to the goods imported and part of the price paid for these goods: o o Upward price adjustments: Customs Authorities will generally require the importer to declare such higher amount and pay duty on the difference Downward price adjustments: Importer will face problems having the Customs Authorities taking account of such rebates (and possibly) get refund of duties. 14

3 b. Transfer Pricing Adjustments – EU VAT • • • Services Adjustments can be made via service charges (eg. marketing or research costs) or by way of correcting the price base for supplies of goods - Prospective adjustments o generally no VAT or customs issue - Retrospective adjustments o Correction of historic positions • Import VAT • Customs - Correction in one single invoice or journal entry Services subject to VAT at the recipient generally fall within the scope of so called ‘reverse charge mechanism’ and should therefore not result in VAT obligations for the supplier It may be challenged, whethere is substance behind the services, respective contracts should be carefully worded and correspond with the actual facts October 8, 2014 15

3 b. Transfer Pricing Adjustments – EU VAT • Supplies of Goods Correction of historic positions - Import VAT o should not be an issue when full input VAT deduction o still something to be observed on both sides of the border - Customs o Correction will lead to customs implications (not in Switzerland!) o Either challenge, why price went down or why it has been lower in the past o to be checked, whether goods are subject to customs duties (eg. Free trade agreements, nature or the goods) - • EU VAT o Compliance: Invoicing, VAT returns, European Sales Listing, Intrastat o Penalties for non-compliance can go up to 200% of the tax due Correction in on single invoice or journal entry - Import VAT & Customs can be an issue since the import value differs from the one in the past - Could be regarded as a way to avoid the issues in historic price adjustments October 8, 2014 16

3 b. Transfer Pricing Adjustments – EU VAT • • • Overall remarks Any payments may trigger VAT and should thus be based on written agreements with proper service descriptions Just to charge local VAT on all transactions is not a solution as this VAT may not be deductible in all jurisdictions Prospective (monthly or quarterly) adjustments • • Retroactive (quarterly or year-end) adjustments • • • Invoices have to be issued meeting all the invoicing requirements Retroactive quarterly adjustments result into the obligation to issue credit notes relating to the previous supplies When credited amounts are without VAT (in case of intra-community supplies of goods), the credited amounts have to be accounted for as adjustments on the EC Sales Listing) Credited amounts related to Intra Community supplies will in principles result into the obligation to make adjustments to previous submitted Intrastat returns. October 8, 2014 17

3 b. Transfer Pricing Adjustments – Canada & US • TP based on estimates acceptable as transaction value at the time of importation, but post-amendment obligations • In Canada, increases to transfer prices require correction required within 90 days of “reason to believe” • In US, increases to transfer prices require correction within 314 days of importation (post-entry amendment) or 21 months of importation (reconciliation program) • Canada has historically relied on s. 48(5)(c) to deny downward TP adjustments • s. 48(5)(c) - price decreases that are effected after importation to be disregarded • • Canada was unique in this approach (versus US, Australia, EU) Refunds not automatic – Documentation will be tested to verify eligibility, in particular to ensure that there was a transfer pricing agreement in effect at the time of importation Canada changed in its policy to allow customs duty refunds for qualifying downward transfer price adjustments by importers last year (January 19, 2015) US has allowed downward TP adjustments since 2012 (usually done through reconciliation program) • Eligibility may be tested in focused assessments – Main requirement is a written “Intercompany Transfer Pricing Determination Policy” 18

4. Best Practices for Compliance Managers and In-House Counsel • Unified approach to income tax and customs/VAT transfer pricing • Coordination of supply chain (logistics) and legal/tax • Unbundling of dutiable from non-dutiable expenses (i. e. , price for goods separate from payments for royalties, management fees, buying agency fees, etc. ) • Sufficiently granular transfer pricing studies (but not enough on their own) • Legal agreements covering purchases of goods, management services, royalties, and other related party payments • Consistency of contemporaneous documentation Ø Transfer pricing study, legal agreements, customs/shipping paperwork, tax filings, commercial documents, accounting records • System of monitoring and correction for adjustments 19

Christina Rinne is partner and a member of Pestalozzi’s Tax group in Zurich. As Indirect Tax specialist she advises domestic, foreign and multinational clients mainly on Swiss and European VAT, Customs and Excise Duty matters as well as Foreign Trade. She is a German Lawyer as well as a Certified German. Tax Expert (“Steuerberater”). Prior to joining Pestalozzi in 2009, Christina Rinne headed the Indirect Tax department of a “Big four” company in Zurich. Having moved to Switzerland in 2001, her work experience spans 18 years of focus on Indirect Taxation in a national and international context. Christina regularly lectures and publishes in the field of Swiss and European Indirect Taxation. She is a member of the Swiss branch of the International Fiscal Association (IFA) as well as of other national and international professional associations. Her professional languages are German and English and she has a good knowledge of French. Christina is admitted to the Bar of Dusseldorf and Zurich and is ranked by Chambers Global 2016 (Tax). Christina. Rinne@pestalozzilaw. com 20

Darrel Pearson, co-chair of Bennett Jones LLP’s international trade and investment practice, is widely recognized in Canada and abroad for his work in the fields of international trade and customs law. He has represented domestic and international clients in many of the most important customs and trade remedy cases before all relevant Canadian Tribunals and Courts, including the only two cases involving customs law and international trade remedy law heard by the Supreme Court of Canada in the last 50 years. Darrel's practice covers the full range of international trade and investment law, and includes a sub specialty focus on the customs valuation aspects of transfer pricing. His customs law practice focuses on minimizing duty, GST, interest and penalties by creatively and compliantly structuring and engineering transactions for customs valuation, tariff classification and tariff preference purposes, as well as internal and external audits and compliance. He has extensive experience with the customs aspects of international transfer pricing. Pearsond@bennettjones. com 21