Limited Risk Models - Sept 4 2013
Limited Risk Models - Sept 4 2013
Limited Risk Models - Sept 4 2013
September 4, 2013
Agenda
Introduction
Locally driven Multiple contact points for the customer Teams working in silos and in certain cases competing within selves Inefficient utilization of resources Increased Costs
Local Manufacturing
Manufacturing units cater only to local demand Inefficient use of Production lines
Enhanced Risk
Each entity in the supply chain functions as an entrepreneur, Each entity carries all the various types of entrepreneur risks
Tax Implications
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Super Normal profits retained in local jurisdictions subject to high tax rates
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Implications
Cash trapped in different jurisdictions
Lower profitability
Globalization
Centralization of Support Services Procurement, HR, Accounting, Admin etc. Centralization of Management functions Sales organizations dispersed Co location of Manufacturing units with vendors and/or markets.
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Country-led Structure
Risk-based profit Value-added profit Profit from in-country operations Risk-based profit Value-added profit Profit from in-country operations Risk-based profit
Center-led Structure
Risk-based profit Value-added profit Risk-based profit Value-added profit Profit from In-Country Operations Profit from In-Country Operations Profit from in-country operations Profit from In-Country Operations Profit from In-Country Operations Profit from in-country operations Risk-based profit Value-added profit
Country 1
Country 2
Country 3
Country 3
Country 2 Country 1
Profit from In-Country Operations Profit from In-Country Operations Profit from in-country operations
Manufacturing
Support Functions
Consequence Fragmented and inefficient supply chain, resulting in higher exposure to risk and overall lowering of profits of the MNE
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Consequence Integration of operational strategy with tax strategy. Centralisation of functions leading to centralization of profits.
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Supply chain efficient centralized business model (with principal at the center)
Headquarters
Management Services
Processing Services
Sell Goods
SUPPLIERS
Purchase Materials
CUSTOMERS
Deliver Materials
Manufacturing Services
Distribution Centre
Key profit drivers (risk, valuable IP) are placed with Principal, who receives entrepreneurial return Other entities perform routine functions (cost plus return)
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Cost Savings
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Toll manufacturer
TM and Principal are related parties
Principal
TM and Principal enter into a longterm toll manufacturing contract, pursuant to which TM agrees to manufacture finished goods for the Principal for an agreed conversion fees Third party suppliers sell raw material and packing material to the Principal. However, the same is consigned to TM for manufacturing The finished goods are delivered pursuant to Principals instructions
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Contract manufacturing
CM and Principal are related parties
Principal
CM and Principal enter into a longterm sales contract, pursuant to which the Principal agrees to purchase finished goods from CM on an arms length basis party suppliers sell raw material and packing material to CM
After manufacturing, the finished goods are stored by CM and are delivered pursuant to the Principals instructions Property in finished goods transferred from CM to Principal
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Imports
Agent of RVEL to promote sale of specified products and to represent, protect and foster the interests of RVEL (Commission 2% of sales)
RVSA could not negotiate or fix prices though it was authorized to process purchase orders RVSA had no authority to bind RVEL qua customers
Customers
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Contradiction: RVSA had no contracting authority and also did not negotiate with customers However, the Court held that the sales promotion by itself did not create a DAPE but taken along with the manufacturing led to the PE conclusion
Decision appears to have been rendered based on incorrect interpretation of law especially the OECD MC Commentary
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Contract Manufacturers
Typical Remuneration Models Return on total operating cost plus markup Return on operating assets
However, where the significant inventory functions and risks are undertaken by the Principal, the contract manufacturer acts akin to a toll manufacturer. The contract manufacturer maybe remunerated on its Value Added Expenses plus a return on its capital invested in the inventory
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Principal $ Services
from
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Principal
Sales #1
Most of the risks are borne by the Principal (e.g., inventory and debtors) and only limited risks are borne by the LRD
Commissionaires in civil law
Sale #2
Customers
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Under the commissionaire arrangement, Zimmer SAS could accept orders, present estimates and documents within the framework of tender offers, conclude sales contracts for Zimmer Ltd without prior approval, and could negotiate prices, grant discounts and payment facilities to existing or new clients without prior approval of Zimmer Ltd. However, Zimmer SAS acted in its own name and could not legally conclude contracts in the name of Zimmer Ltd. Hence no privity of contract between Zimmer Ltd and customer
French tax authorities assessed Zimmer Ltd to French income tax on the ground that it had an agency PE in form of Zimmer SAS
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clients have no direct action against the principal; hence the requirement of agency PE under
OECD MC is absent
Held no agency PE since the commissionaire was not binding the principal qua third party customers, which according to Court was a prerequisite under OECD MC for constituting an agency PE
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Dell AS, a Norwegian company, was acting as a commissionaire agent on behalf of its Irish parent, Dell Products Dell AS sold computer products of Dell Products to companies in Norway under its own name. Dell AS could not conclude contracts on behalf of its parent Norwegian tax authorities argued that Dell AS constituted a PE of Dell Products in Norway Norways Supreme Court ruled that the activities of a Norwegian subsidiary do not create an agency PE in Norway of its Irish parent sales company The Court specifically held that a PE in accordance with article 5(5) of the OECD Model Treaty (agency PE article) can arise only in cases in which a dependent agent can legally bind its principal Referred to Zimmer French SC decision
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Dell AS (Norway)
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Above amendment has been proposed to overrule the Zimmer and Dell decisions
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Essentially the functions of an Agent and LRD are broadly similar. Accordingly, an agent maybe remunerated based on a return on Sales of an LRD with appropriate economic adjustments like working capital adjustment etc.
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In the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export (Expln 1(b) to S. 9)
business connection" shall include any business activity carried out through a person who, acting on behalf of the non-resident, (a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the purchase of goods or merchandise for the non-resident (Expln 2(a) to S. 9)
d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;
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buyers expectations
Vendor identification Review of costing data Vendor recommendation Quality control
Monitoring vendors for compliance with the policies, procedure and standards related quality,
performance etc.
Negotiating competitive prices Providing training to selected vendor employees Ensuring usage of standard methods, tools, machinery and layouts
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Procurement services should normally not result in a PE. All activities inextricably linked to the procurement function should qualify for the exemption benefit
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design, preparing vendor databases, price and terms negotiation, etc. maybe remunerated
with a commission on goods purchased
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Principal
India
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IP Migration
Transfers of intangible property rights to a central entity (e.g. an IP company) within the group.
Para 9.80 of the OECD Transfer Pricing guidelines on Business Restructuring Relevant intangible assets might potentially include rights to use industrial assets such as patents, trademarks, trade names, designs or models, as well as copyrights of literary, artistic or scientific work (including software) and intellectual property such as knowhow and trade secrets. They may also include customer lists, distribution channels, unique names, symbols or pictures. An essential part of the analysis of a business restructuring is to identify the significant intangible assets that were transferred (if any), whether independent parties would have remunerated their transfer, and what their arms length value is.
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Any transfer of marketing intangibles i.e. customer list, distribution network, etc.
Any transfer/ surrender of a right i.e. early/ premature termination of exclusive rights of distribution under an agreement Any cessation of functions including movement/ transfer of workforce with or without bundling of intangibles with the work force Others The above in-depth analysis would be required to determine if an exit charge would be expected between independent parties
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Does exit charge represent non-compete fee or does it represent consideration payable for stripping the subsidiary from certain rights previously held by it as a full risk distributor?
If not non-compete fee, capital receipt not taxable as business income (compensation for loss of revenue earning apparatus)?
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Arguable that if charge represents compensation towards loss of revenue earning apparatus, not taxable as capital gains relying on B.C. Srinivasa Shetty (Supreme Court)
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