Transfer Pricing Topics For High Tech Companies

INFORMATION, COMMUNICATIONS & ENTERTAINMENT
Transfer Pricing Topics for

High-Tech Companies
TAX
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firms of the KPMG network of independent firms are affiliated with KPMG International.
KPMG International provides no client services. No member firm has any authority to
obligate or bind KPMG International or any other member firm vis--vis third parties, nor
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Table of Contents

Page
INTRODUCTION 4
I. THE CURRENT TRANSFER PRICING ENVIRONMENT
Considerations for Acquisitions
U.S. Regulatory Developments
10
U.S. Final Services Regulations and Cost Sharing Regulations 10

OECDs New Guidelines
12
India and China Enforcement
14
Added Enforcement in Japan
16
II. RECENT TRENDS IN THE ECONOMIC ENVIRONMENT
18
Increased Tax Controversy
19
Economic Downturn and Uncertain Timing of Recovery
22
Recognition of Losses
23
Restructuring 24
III. RECENT TRENDS IN THE BUSINESS ENVIRONMENT
26
Conversion to Fabless Chip Companies
26
Software as a Service and Cloud Computing
27
Changes to Revenue Recognition
28
CONCLUSION 32
Introduction
Since 2008, the world has experienced an unprecedented global economic shock
that has presented challenges to nearly all aspects of business and corporate
activity: broad business models, financial planning and analysis, customer and vendor
relationships, government relationships, as well as intercompany activities. Many
corporate decision makers have focused on revising their business models to fit the
near-term business reality while seeking some ability to forecast in this uncertain
environment. This reduced foresight has posed challenges, requiring these decision
makers to potentially reconsider key relationships with suppliers, customers, the
government, and other related parties.
This white paper aims to

provide commentary on
several timely transfer
pricing topics for high-tech
companies, including:
The current transfer
pricing environment
Recent trends in the
economic environment
Recent trends in the
high-tech business
environment.
As of summer 2010, there are strong signs that many emerging markets are
recovering, and there are nascent signs that the global economy is beginning to
stabilize. According to the World Bank, although global growth is expected to turn
positive in 2010, the pace of the recovery will be slow and subject to uncertainty.
The World Bank says global output contracted by 2.1 percent in 2009, but is forecast
to register positive growth of 2.9 and 3.3 percent in 2010 and 2011, respectively.
The main drag on global growth is coming from high-income countries, whose
economies contracted by 3.3 percent in 2009 and are only expected to grow
between 2.1 and 2.3 percent in 2010 and between 1.9 and 2.4 percent in 2011, due
primarily to ongoing issues from the European debt crisis. Prospects for developing
countries are for a relatively robust recovery in 2010, with growth of 5.7 to 6.2
percent continuing out to 2012.1
Should this growth spread to more established Organisation for Economic
Co-operation and Development (OECD) economies,2 the general expectation is that
initial public offering (IPO) and merger and acquisition (M&A) activity will rebound in
the coming year. Preliminary data for the first quarter of 2010 show that the volume
of announced technology M&A activity rose to its highest level since the breakout
of the financial crisis, and deal activity could further increase as the economy
improves.3 Accordingly, this white paper will adopt a positive outlook and address
some considerations for high-tech businesses that are either contemplating or
executing a business expansion, acquisition, or other combination in the face of new
market realities and a changing regulatory environment.
This white paper considers three regulatory documents: OECDs new Transfer
Pricing Guidelines (OECDs New Guidelines), the Final Services Regulations,4 and
the Temporary Cost Sharing Regulations5 in the United States, as well as focused
transfer pricing scrutiny globally, with particular attention to China and India.
While the general business outlook appears to be improving, the past two years have
wreaked havoc for many high-tech companies. While corporate profitability may
have been more challenging than ever before for this sector, many governments are
even further in the red. Governments have been increasing federal spending to spur
economic growth and provide increased social services, such as unemployment
benefits. This spending has been accompanied by reduced tax receipts generating
significant deficits. Not surprisingly, many governments are focused on increasing
revenue from multinational companies by asserting any profits arising from the
1 THE WORLD
4 Transfer Pricing Topics for High-Tech Companies
BANK, GLOBAL ECONOMIC PROSPECTS SUMMER 2010: FISCAL HEADWINDS AND RECOVERY (June 9, 2010),
http://www.worldbank.org/globaloutlook.
2 As of May 2010, OECD member countries are Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece,
Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain,
Sweden, Switzerland, Turkey, United Kingdom, and the United States. Countries invited to open discussions for membership are Estonia, Israel, Russia,
and Slovenia. Finally, Brazil, China, India, Indonesia, and South Africa received enhanced engagement, which has the potential in the future to lead to
membership.
3 Cyrus Sanati, Tech M&A Shows More Signs of Rebounding, N.Y. TIMES, Apr. 5, 2010, http://dealbook.nytimes.com.
4 On July 31, 2009, Treasury and the IRS filed with the Federal Register final regulations regarding the treatment of controlled service transactions under
section 482 (T.D. 9456, 74 FED. REG. 38830 (Aug. 4, 2009) (hereinafter Final Services Regulations)).
5 On December 31, 2008, the U.S. Treasury Department and IRS releasedin temporary and proposed formregulations addressing a cost sharing
arrangement (CSA) among controlled taxpayers. The new temporary regulations took effect upon publication in the Federal Register on January 5, 2009
(T.D. 9441, 74 FED. REG. 340 (Jan. 5, 2009) (hereinafter Temporary Cost Sharing Regulations)).
Transfer Pricing Topics for High-Tech Companies 5
business are linked to their jurisdiction. As discussed in detail later in this document,
tax audit controversy (specifically related to transfer pricing) was up sharply in 2009
and is expected to continue this trajectory in 2010 and beyond. Even if global markets
improve and there is less tension on transfer pricing in 2010, the results from these
challenging years will remain open for controversy for the next several years.
While a companys financial statements and tax return generally focus on the year
at hand, many transfer pricing methodologies incorporate multiple years of data
in the analysis. Thus, for most companies, at least some transactions will include
the results of these bad years that will impact the transfer pricing analysis and
documentation for another three years. Importantly, tax authorities will have the
opportunity to scrutinize any unusual results retrospectively for multiple tax years.
In this economic climate, KPMG firms are seeing the continuation of certain
high-tech business trends such as increased separation of chip design and
semiconductor manufacturing and increased offerings of software as a service
and cloud computing, a style of computing where massively scalable and elastic
IT-related capabilities are provided as a service using Internet technologies
to multiple external customers.6 From an accounting perspective, new revenue
recognition rules in the United States could lead to business changes with respect to
contract terms and negotiations as well as incentives to sales teams. Each of
these trends has implications on a companys tax and transfer pricing policies.
This paper provides a perspective from KPMG on cross-border activities of high-tech
companies in the current environment, and can serve as a catalyst for executive-level
discussion and proactive management of transfer pricing impacts and opportunities.
6 Partha
Iyengar, Gartner Symposium ITxpo, Application Development in the Cloud: Strategies and Tactics for a New Generation (Nov. 11, 2008).
The significance of transfer

pricing in a global economy
where multinational
enterprises play a prominent
role [] is especially relevant
in the midst of the current
economic challenges, when
the location of profits and
losses within a multinational
group is very sensitive as it
directly affects the groups
effective tax rate. Governments
also are carefully monitoring
the allocation of profits and
losses to their jurisdictions,
in a context where many of
them are striving for a balance
between business-friendly,
pro-growth tax measures
and measures to maintain the
needed level of tax revenues to
support public spending.
Organisation for Economic Co-operation and
Developments Centre for Tax Policy and
Administration
I. The Current Transfer

Pricing Environment
Transfer pricing and

an increased focus
on international
enforcement activity
are garnering
attention at the
highest levels of
government.
The current transfer pricing environment is one of intense scrutiny from nearly
every jurisdiction with transfer pricing regulations. Macroeconomic forces have
governments desperately seeking to stem budget deficits, and multinational
corporations are seen as a key source of revenue. Many major jurisdictions,
such as China, France, India, Ireland, Japan, the United Kingdom, and the United
States, are reviewing their broader international tax policy and more rigorously
enforcing existing regimes. Transfer pricing and an increased focus on international enforcement activity are garnering attention at the highest levels of the
government.
Notably, China, France, and Ireland have recently introduced new transfer pricing
regimes. Chinas new Corporate Income Tax Law, effective from January 1, 2008,
contains new transfer pricing regulations clarified in Guoshuifa [2009] No. 2.
France
In France, a new transfer pricing documentation requirement, codified as Article
L13AA, was enacted into law in France on December 30, 2009, applying for all
accounting periods beginning on or after January 1, 2010.
Japan
In Japan, an amended tax law and Cabinet Orders and Regulations (Ministry
Ordinance) were promulgated on March 31, 2010, that include an amendment to
Article 66-4(7), practically introducing documentation requirements.
Ireland
On February 4, 2010, the Irish Taxation Institute introduced a new transfer pricing
regime through the 2010 Finance Bill. In particular, Part 35A of the Bill sets out
transfer pricing rules that apply the arms-length principle to trading transactions
between related parties. Transfer pricing will likely be a critical factor in this review
of overall international tax policy.
India
In India, the Finance Minister released a draft on the Direct Taxes Code (DTC) Bill
and a Discussion Paper in August 2009. The DTC is currently in a draft stage and
had been thrown open for public comments. The Finance Ministry is working on
the comments received and proposes to table another draft soon. The DTC is
proposed to be effective from April 1, 2011. When enacted, the DTC would replace
the dated and existing Income-tax Act, 1961 (Income-tax Act) and the Wealth-tax
Act, 1957 (Wealth-tax Act).7 Along with replacing the Income-tax Act, the DTC
seeks to introduce several new transfer pricing provisions, including advance pricing
agreements (APAs), anti-avoidance provisions, changes in conducting transfer pricing
field audits, etc.
United Kingdom
The U.K. tax authority (HM Revenue & Customs) on March 8, 2010, released
updates to its thin capitalization guidance. In general, the new guidance indicates the
increased scrutiny that the U.K. tax authorities will apply in addressing thin capitalization situations and is part of a broader international tax reform effort.
United States
President Obama proposed additional Internal Revenue Service (IRS) resources with
respect to international enforcement. And in its recent Strategic Plan 20092013,
the IRS highlighted the importance of hiring more examiners and providing those
individuals with the sophisticated training and tools necessary for them to effectively
do their job. On January 26, 2010, IRS Commissioner Doug Shulman addressed the
New York State Bar Association and stressed the increase in transfer pricing-focused
professionals at the IRS and the efforts to improve the transfer pricing auditing
processes.8 As the IRS continues to coordinate enforcement efforts with the tax
agencies of U.S. treaty partners, multinational taxpayers will need to be constantly
aware of the activities of their affiliates throughout the worldand in particular, to
be aware of any ongoing or impending transfer pricing examinations and potential
issues. One area ripe for transfer pricing controversy is the treatment of acquisitions.
As companies outlooks improve, many companies will seek growth through

mergers or acquisitions. Accordingly, business combinations may be the fastest
path to revenue and earnings growth in the near term. This integration of companies
will be under increasingly intense scrutiny. Meanwhile, budgets for both internal
and external resources to assess the impact of the transaction and make sound
judgments related to the integration are likely more limited than ever before. While a
great deal of focus is appropriately placed on the business impact of the transaction
from a finance, accounting, operations, IT, or other perspective, there are also critical
aspects of the deal, such as the business structure, that must be addressed for tax
and, specifically, transfer pricing purposes.
IP and Transfer Pricing

Two of the most important transfer pricing questions arising from a material merger
or acquisition are: 1) What happens to the intangible property (IP); and 2) To what
extent will the supply chains be integrated? With respect to the IP, it is important
that IP ownership, both legal and beneficial, be clearly established during the due
diligence process prior to the transaction. The next step is to determine what entity
should ultimately own the IP post-closing. If the IP is not being moved and the supply
chains are to remain separate, then the key items are establishing the support for
the ownership post-closing and to provide evidence that the IP is intended to remain
separate on a go-forward basis.
2010), www.irs.gov.
The following checklist, while not

exhaustive, may help to identify
areas of transfer pricing exposure
faced by high-tech companies
involved in acquisitions.
Where is the IP of the acquiring
company located?
Where is IP of the target company
located?
Does the acquiring company or
the target have an international IP
structure?
Is the targets transfer pricing
methodology consistent with the
acquirers? Should it be adapted to
the acquirers?
Will the target be integrated into
the acquiring company structure?
How will the integration affect
movement of IP or manufacturing?
Will there be any plant closings or
other cessation of operations?
Considerations for Acquisitions
7 KPMG LLP (United States) TaxNewsFlash-Asia/Pacific 2009-50, India: Direct Tax Code 2009Highlights (Aug. 14, 2009).
8 Doug Shulman, IRS Commissioner, Prepared Remarks to New York State Bar Association Taxation Section Annual Meeting
Transfer Pricing Checklist for

Mergers and Acquisitions
in New York City (Jan. 26,
Where will restructuring costs be

booked?
Can intercompany and customer
contracts be assigned?
Will new agreements need to be
put in place on an interim and final
basis?
If there are changes to the IP or
manufacturing flows, what is the
impact on invoicing?
Does the target company have
transfer pricing documentation?
Do the intercompany contracts
accurately reflect the actual flows
taking place?
Will the integration of the
acquired IP affect the status
of any preexisting cost
sharing arrangement under
U.S. Temporary Cost Sharing
Regulations?
For many companies, the complexity of managing distributed IP ownership from a

business and legal perspective outweighs the potential tax cost of consolidating the
IP in a single jurisdiction, which is often the parent companys high-tax jurisdiction. If
the IP is moved, then the key questions are:
Who are parties to the transaction?
What is the value of the IP or, more specifically, can the IP be valued directly or
inferred from the merger or acquisition price?
What modifications will need to be made to the existing supply chain to embrace
the new IP?
As part of the due diligence process, the existing legal and beneficial ownership
of IP should be clearly established. The management of the combined entity
will determine the buyer of IP. The jurisdictions in which the buyer and seller are
located may impact the value of the transaction, namely because different taxing
authorities hold differing views on the underlying asset. Some may view IP as a
discrete transaction analogous to the IP value assigned to a specific asset, such as
technology, in a purchase price allocation for financial statement purposes. While
an increasing number of other tax authorities view an outbound transfer of IP as a
transfer of a business, this view presumes a larger, even significantly larger, value for
IP. Further, the view of the taxing authority regarding the nature of the transaction
may be different for inbound versus outbound transactions. Specifically, taxing
authorities may respect a narrower definition of IP, which suggests that they would
respect a lower value for an inbound transaction than for an outbound transaction
with similar facts.
If the consolidated IP will flow through the acquirers existing supply chain, existing
intercompany agreements should be reviewed to ensure accuracy and inclusion of
new IP. Further, a high-tech company must carefully consider whether the existing
pricing policy makes sense for the new transactions. If the new policy is materially
different than the acquired companys existing policy, one should also consider
whether there is any tax exposure arising from the conversion. For example, if the
acquired company sold its goods through a commission agent/commissionaire
network and the acquirer sells its goods through buy-sell distributors, then
intercompany contracts, as well as activities undertaken and risks assumed, must be
reviewed to ensure consistency with new pricing policy.
For companies without a cost sharing agreement (CSA), a significant merger or
acquisition may provide an opportunity to consider the potential benefits, as well as
the risks, of IP pooling arrangements such as a CSA, joint venture, or partnership.
For companies with an existing CSA or cost contribution arrangement, the IP may
have to be added to the scope of the existing CSA or cost contribution arrangement
(CCA). All of the valuation considerations noted above apply.
Who are parties to the transaction? This is particularly important to establish in a
CSA context as it impacts the shares of expected benefits.
What is the value of the IP, or more specifically, can the IP be valued directly or
inferred from the merger or acquisition price?
What modifications will need to be made to the existing supply chain to embrace
the new IP?
Further, for cost sharing transactions involving a U.S. party, specific valuation
methodologies are set forth in Treas. Reg. section 1.482-7T. There are a few specific
new administration requirements in these regulations that pertain to the expansion of
a CSA:
An update agreement must be signed and dated within 60 days of inclusion in the
CSA (Treas. Reg. section 1.482-7T(k)(1)(iii)).
The annual statement must include this expansion, which is due upon filing of the
next return (Treas. Reg. section 1.482-7T(k)(3)(iii)(B)).
The new regulations seem particularly concerned about a material change in scope
such that a material change in scope thrusts the entire CSA into the new regulations.
However, what constitutes a material change in scope is not defined, and the
regulations do not provide examples to clarify this point. Taxpayers may consider
whether it is appropriate in the amendment to the agreement or other supporting
working papers to assert whether individually or cumulatively this expansion
constitutes a material change in scope. However, we recommend taxpayers consult
their internal or external legal counsel prior to making these changes.
IP transfers are not the only outbound transfers attracting the attention of tax
authorities. A wide range of business restructurings, including plant closings as well
as other downsizings or functional realignments, are being evaluated. While these
events may arise from strategic corporate decisions at any point in time, they are
often considered during the integration of a merger or acquisition. Any restructuring
activity in which the functions, risks, or profits of one legal entity are transferred to
a related party in another jurisdiction warrants consideration of whether potential
exit charges may be assessed by the local taxing authority. We are seeing taxing
authorities assert that these restructurings are an outbound transfer of a business,
much like the treatment of transfers of outbound IP. This point is addressed further in
the discussion of the OECDs New Guidelines.
One of the key takeaways is

that one must ensure that the
transfer pricing implications
are factored into the business
integration. Specifically,
The pre- and postacquisition IP ownership
must be clearly established.
If IP is migrated, care must
be taken in its valuation.
If operations are migrated,
care must be taken in
evaluating potential exit
charges.
Subsequent impacts to
the supply chain must be
reflected in intercompany
pricing policy.
Any significant change
in functions and
responsibilitiesincluding
plant closingsare
regarded as business
restructurings under the
issued in July 2010.
U.S. Regulatory Developments

Final Services Regulations
Most multinationals have some level of intercompany services. High-tech companies
are, by their very nature, even more likely to have extensive cross-border service
transactions as they are likely to have global operations and services embedded
in the creation or delivery of their offerings. Recent trends, such as provision of
software-as-a-service (also known as SaaS) and complex implementation and
integration services offered alongside software or hardware offerings, are further
increasing the complexity of intercompany service transactions. Accordingly, the
distinction between IP transactions and services transactions is increasingly blurred.
On July 31, 2009, Treasury and the IRS filed Final Services Regulations with the
Federal Register regarding the treatment of controlled service transactions under
section 482.9 These regulations adopted, with a few minor clarifications, the
temporary regulations that expired the same day.10 These Final Services Regulations
cross-reference the IP regulations and explicitly state that the arms-length
determination should be similar whether reviewed under Treas. Reg. section 1.482-9
or Treas. Reg. section 1.482-4.11
As high-tech companies
migrate functionality
to geographic clusters,
two common issues
arise. One is that
there is tension in
jurisdictions such as
the United States and
China where there is
an increasing number
of service transactions
and the respective
transfer pricing
rules are not entirely
consistent. Further,
business unit leaders
often do not appreciate
that centralization of
certain services can
have profound tax
and transfer pricing
implications.
As high-tech companies migrate functionality to geographic clusters, two common

issues arise. One is that there is tension in jurisdictions such as the United States
and China, where there is an increasing number of service transactions and the
respective transfer pricing rules are not entirely consistent. Further, business unit
leaders often do not appreciate that centralization of certain services can have
profound tax and transfer pricing implications.
Temporary Cost Sharing Regulations

CSAs are pervasive for high-tech companies in the United States. Recent changes
in these rules have broad implications for the full spectrum of high-tech companies
from start-ups to established companies. On December 31, 2008, the U.S. Treasury
Department and IRS releasedin temporary formcost sharing regulations
addressing a CSA among controlled taxpayers. The new Temporary Cost Sharing
Regulations took effect upon publication in the Federal Register on January 5,
2009. These regulations replaced the prior cost sharing regulations found in Treas.
Reg. section 1.482-7, which were issued in 1995. The Temporary Cost Sharing
Regulations generally follow proposed regulations issued in August 2005. In general,
the Temporary Cost Sharing Regulations are more detailed than the 2005 proposed
regulations, as key elements such as the investor model and the various methods
(e.g., the income method and the residual profit split method) for determining the
value of PCTs (platform contribution transactions or, formerly, buy-ins) continue as
elements of the temporary regulations.
Generally, the Temporary Cost Sharing Regulations are viewed as less favorable to
taxpayers than prior regulations such that, in most instances, CSAs created under the
new rules may take longer to provide benefit, and that benefit may be diminished.
For existing CSAs, the tension will lie in adherence to the new administrative rules
and expansion in scope of the CSA, both from internal development and M&A
activity.
9 The
final regulations also modify the regulations under section 861 concerning stewardship expenses to be consistent with the changes made to the
regulations under section 482.
10 Treas. Reg. 1.482-9T (h)(3), 71 FED. REG. 44466 (Aug. 4, 2006).
11 Treas Reg. 1.482-9T(m)(3).
As companies with cost sharing arrangements file their tax returns, attention should
be paid to certain technical requirements in the new regulations. Specifically, the
regulations require that each controlled participant attach a CSA Statement
providing certain information regarding the arrangement and its participants.12 For
taxpayers with an existing CSA, the first CSA Statement was due September 2,
2009.13 Subsequent statements are filed with the participants tax return (or Form
5471, etc., if the participant does not file a U.S. tax return).14 Generally, failure to
comply with these requirements allows the IRS to deny the taxpayer relief under the
transition rules of cost sharing regulations.15
The Temporary Cost Sharing Regulations also imposed other constraints on CSAs.
One such limitation is the requirement that each participant have non-overlapping
interests. These rights must be assigned by geographic exclusivity or adhere to
the four-part non-overlapping interests rule.16 The IRS had originally proposed that
participants must have exclusive geographic rights, but modified the regulations to
be less restrictive non-overlapping interests. Nonetheless, this restriction on the
assignment of rights can hamper common business practices such as selling global
contracts to a customers headquarter entity.
Another new limitation is that intangibles acquired in a post-formation acquisition
(PFA) that are expected to contribute to the intangible development activity must
be promptly integrated into the CSA. This inclusion of IP generally constitutes
a modification of the CSA. All modifications require contemporaneous written
contractual agreements within 60 days of the first occurrence of any intangible
development costs (IDCs).17 As a practical matter, executing such written
agreements within 60 days is very challenging.
Whether or not a high-tech company has a CSA, the new cost sharing regulations
change the landscape in which intangibles are valued in the United States. IP
transactions are the lifeblood of high-tech companies. The regulations include
new specified methods18 required to be considered by taxpayers for use in IP
transactions, regardless of whether or not in connection with a CSA.19 These new
specified methods include the acquisition price, market capitalization, and income
methods. Each of these methods can result in valuations higher than those resulting
from methods arising from the prior Treas. Reg. section 1.482-7 for cost sharing
or the existing Treas. Reg. section 1.482-4 for transfers of IP as commonly applied
by taxpayers. Further, the regulations explicitly state that valuations resulting from
purchase price allocations performed for financial statement purposes are not
necessarily adequate for valuing acquired intangibles, although it is acknowledged
that such valuations may be an appropriate starting point.20 While these rules pertain
specifically to cost sharing arrangements, they must be at least considered in all
services and IP transactions through cross-references (coordination rules) in the
transfer pricing regulations.
In addition to this new regulatory complexity in the United States, high-tech
companies must consider the global regulatory environment. For instance, in the
OECD there are several initiatives ongoing, which resulted in the OECDs New
Guidelines.
12 Treas. Reg. 1.482-7T(k)(4).

13 Treas. Reg. 1.482-7T(m)(2)(viii).
14 Treas. Reg. 1.482-7T(k)(4)(iii).
15 Treas. Reg. 1.482-7T(m)(1).
16 Treas. Reg. 1.482-7T(b)(4)(iv).
17 Treas. Reg. 1.482-7T(k)(1)(ii)(K)(iii).
18 Treas. Reg. 1.482-7T(g)(1).
19 Treas. Reg. 1.482-4T(g).
20 Treas. Reg. 1.482-7T(g)(2)(vii).
Whether or not a
high-tech company has
a CSA, the new cost
sharing regulations
change the landscape
in which intangibles are
valued in the United
States. IP transactions
are the lifeblood of
high-tech companies.

On July 22, 2010, the OECD released a new edition of the Transfer Pricing Guidelines
that 1) updated prior guidance in Chapters IIII, and 2) provided new guidance on
the transfer pricing issues presented in the context of business restructuring. These
new Guidelines represent the results of several years of intensive work on the part of
the OECD exploring issues related to comparability, the use of transactional profits
methods, and business restructuring.
Perhaps the most

important outcome of
this work is a strong
reaffirmation that the
pricing of transactions
among associated
enterprises should
be based on the
arms-length principle,
i.e., that it should
reflect the prices that
would have been set,
had those transactions
taken place among
independent entities.
Perhaps the most important outcome of this work is a strong reaffirmation that
the pricing of transactions among associated enterprises should be based on the
arms-length principle, i.e., that it should reflect the prices that would have been set
had those transactions taken place among independent entities. Thus, the goal of
the OECD Transfer Pricing Guidelines remains the same, even though the detailed
guidance on how to reach this goal has been updated in several important respects.
Another welcome development is that the new Guidelines reaffirm, as was the case
in 1995, that tax authorities should respect the transaction actually undertaken by
the taxpayer in all but extraordinary circumstances, which are defined as rare or
unusual. Such exceptional cases are defined as situations in which 1) the substance
of a transaction differs from its form or 2) the arrangements made in relation to the
transaction, viewed in their totality, differ from those that would have been adopted
by independent enterprises behaving in a commercially rational manner and the actual
structure practically impedes the tax administration from determining an appropriate
transfer price. The guidelines emphasize the importance of having a clear explanation
of the structure of controlled transactions in terms of functions, assets, and risks,
both before and after restructuring. Accordingly, written agreements with respect to
intra-group transactions are recommended.
One key change in Chapters IIII is the replacement of the hierarchy of methods with
a requirement to select the most appropriate method to the circumstances of the
case. Under the prior 1995 guidelines, transactional profit methods, and in particular
the transactional net margin method, were treated as methods of last resort
that should only be used if the three traditional transaction methods (comparable
uncontrolled price method, resale price method, and cost plus method) could not be
applied. The updated guidelines indicate that taxpayers and tax authorities should use
the most appropriate method based on facts and circumstances, acknowledging that
transactional profit methods may be more practical/reliable in many cases. This is,
in effect, an acknowledgement of the changes in transfer pricing practice that have
evolved since 1995.
There is also a substantially more detailed discussion of the application of transactional
profit methods than was found in the 1995 Guidelines. For the most part, this
additional discussion is welcome in that it acknowledges the range of issues that
exists and generally provides a reasonable amount of flexibility to tax authorities and
taxpayers in approaching such issues. In some cases, however, the level of detail is
troubling in that it may lead to the adoption of prescriptive approaches by some tax
authorities. For example, paragraphs 3.4 and 3.5 describe the steps in a typical
comparability analysis that can be followed as a good practice. While there is nothing
that is per se unreasonable with this list, equally reasonable alternative approaches
may be possible, and make more sense, in many circumstances (as acknowledged at
paragraph 3.4 itself).
The new guidelines also contain a much more robust discussion of risk than the 1995
guidelines. The guidelines make it clear that tax authorities should generally respect
the contractual allocation of risk established by the multinational enterprise subject,
however, to:
The purported contractual allocation of risk between associated enterprises being

consistent with the economic substance of the transaction
The conduct of the parties being consistent with the contractual allocation of risk
The allocation of risk in the controlled transactions being arms length.
Perhaps the most important of these factors is the need to demonstrate that the
controlled transaction is arms length. In discussing this, the guidelines state that
taxpayers can show that an agreement is arms length by either 1) showing that
there are comparable third-party arrangements with a similar allocation of risk, or
by 2) demonstrating that, while not seen in a third-party arrangement per se, the
allocation of risk is, in fact, one that could be expected among independent parties.
In showing the later, the guidelines stress the importance of control over risk and
of the financial capacity to assume risk at the time of the risk allocation or transfer.
In discussing control, the guidelines note that the risk-bearer would be expected to
make decisions to take on the risk (decision to put the capital at risk) and decisions
on whether and how to manage the risk, internally or using an external provider. This
would require it to have peopleemployees or directorswho have the authority
to, and effectively do, perform these control functions. The guidelines acknowledge
that control does not require the day-to-day management of the risk, but state that
in cases where the management of the risk is outsourced, the risk-bearer would
generally be expected to make a number of relevant decisions to control its risk,
including 1) taking responsibility for the decision to hire or terminate the entity that
is managing risk on a daily basis on its behalf, 2) determining the type of work that is
being done, 3) making key spending decisions, and 4) assessing the outcome of the
work done. In discussing financial capacity to assume risk, the guidelines suggest
that the risk bearer should generally have sufficient financial resources to assume
the risk at the time of the contractual allocation or transfer of risk to it, but also note
that the financial capacity to assume the risk is not necessarily the financial capacity
to bear the full consequences of the risk materializing, as it can be the capacity for
the risk-bearer to protect itself from the consequences of the risk materializing.
Furthermore, a high level of capitalization by itself does not mean that the highly
capitalized party carries risk.
The release of the new Chapter IX on business restructuring is also an important
development. Business restructuring is defined very broadly to include: the
cross-border redeployment by a multinational enterprise of functions, assets and/
or risks. In essence, a business restructuring can involve almost any substantive
change in an intra-group business relationship: a change in the nature or scope of
transactions between the associated entities involved, a shift in the allocation of
risks among group entities, a change in responsibility for specific functions, or the
termination of a commercial relationship between associated enterprises. To the
extent that local documentation requirements extend to business restructuring,
multinational enterprises may be expected to document a much broader range
of changes in their business operations than has been expected in the past. In
documenting these changes, it is important to consider:
The initial structure
The new structure
The transfers of assets and/or substantial changes of contractual relationship
between associated enterprises
What paymentsif anywould be expected at arms length for those transfers or
substantial contractual changes in order to go from one structure to the other.
In essence, a business
restructuring can involve
almost any substantive
change in an intra-group
business relationship: a
change in the nature or
scope of transactions
between the associated
entities involved, a shift
in the allocation of risks
among group entities, a
change in responsibility
for specific functions,
the termination of a
commercial relationship
between associated
enterprises.
Chapter IX states very clearly that the arms-length principle does not, and should
not, apply differently in the case of post-restructuring transactions than in other
transfer pricing contexts. Moreover, the guidelines state that under the arms-length
principle there is not always a need for a payment because of a business
restructuring or because of the termination of a business relationship. The guidelines
take the position that payments are not needed for the mere transfer of profit
potential, but note that they are required if compensations would be expected for
comparable transactions among parties operating at arms-length.
Finally, the newly released guidelines emphasize the need to consider the
alternatives that are realistically available to each of the controlled participants to
the controlled transaction. This evaluation of realistic alternatives is intended to be
somewhat pragmatic in naturethere is no need to explore all possible different
options that could have been consideredbut does allow taxpayers and tax
authorities to consider alternative options that may be available to each participant to
the controlled transaction. It is important to note that:
The examination of options is two sidedthe options of both the controlled seller
and the controlled buyer may have to be taken into account.
While the new

guidelines may not
address all issuesfor
example, the discussion
of losses does not seem
to acknowledge that
losses are a relatively
common outcome of
business investments,
and that once incurred
they may never be
recoveredbut, in
general, the updated
guidelines are an
important step forward.
The analysis has to be done from the perspective of the controlled affiliate as a
stand-alone entity rather than from the perspective of the corporate group.
While the new guidelines may not address all issuesfor example, the discussion of
losses does not seem to acknowledge that losses are a relatively common outcome
of business investments, and that once incurred they may never be recovered
but, in general, the updated guidelines are an important step forward. But the key
question, of course, is: How will the new guidelines be interpreted and applied by the
local tax authorities?
Please visit the OECD Web site for more information on the OECDs New Guidelines.
India and China Enforcement

India
Since the beginning of the decade, there has been a rush to set up operations
in India. A wealth of highly trained, multilingual professionals was available for
significantly reduced wages when compared to more developed countries. In
addition to favorable labor costs, Indias government officials incentives such as tax
holidays to attract businesses to India. As late as the 1990s, few multinationals,
including high-tech companies, had significant operations in India. Now, it is common
for a high-tech multinational to have a presence in India.
This surge of multinational presence has focused considerable attention on Indias
transfer pricing regime. Indias transfer pricing regulations were released in 2001,
and shortly thereafter, i.e., in 2003, transfer pricing audits effectively began. The
Central Board of Taxes in India introduced a specialized cell of trained officers that
is responsible for all transfer pricing audits. Over the past years, there has been a
significant increase in the number of transfer pricing audit officers (TPOs). The
TPOs in this short time have positioned Indias transfer pricing administration as an
aggressive one.21
21 Hardev
Singh & Saurabh Dhanuka (KPMG in India), How to Survive a Transfer Pricing Audit In India, TP WEEK, May 22, 2008.
Further, in the past couple of years, the TPOs have made significant transfer pricing
adjustments to the income of several multinational enterprises operating captive
centers in India, especially in the areas of technology and services. Indias revenue
authorities have also made transfer pricing adjustments on account of royalty
and management fee payouts by subsidiaries in India of high-tech companies
headquartered in the United States and other parts of the world. The fact pattern of
adjustments indicates that one in every four cases picked up for audit is adjusted.
While transfer pricing adjustments are increasingly common, it is noteworthy that the
U.S. and India competent authorities reached a negotiated settlement on a transfer
pricing dispute in May 2010.
Other unique factors include currency controls, services payments, and expatriation
of IP to tax havens. Currency controls, while modified recently,22 generally
complicate extracting cash from operations in India for use in other activities. The
liberalized currency controls now permit all payments for royalty, lump-sum fee for
transfer of technology, and payments for use of trademark/brand name under the
automatic route without any restrictions. However, it becomes equally important
for a company to ensure that these liberalized payments adhere to the arms-length
standard.
Indias authorities tend to scrutinize the inbound provision of services to companies
in India that would result in an outbound payment further reducing mechanisms
for extracting cash from Indian operations. Indias government, more specifically
its transfer pricing authorities, asserts that companies in India should capture all
of the location savings of outbound services generally through a markup that is
considerably higher than those observed for similar transactions in other jurisdictions.
Some of the other scenarios that would attract the attention of the TPOs for a
transfer pricing audit would be:
Consistent losses of the taxpayer attributable to intercompany transactions
Significant changes in the profitability of the taxpayer and its associated
enterprises
Unjustifiably large payment of management charges not passing the benefit test
Losses incurred by routine distributors.
Further, Indias taxing authority has placed significant hurdles to extracting IP from
India such that it is unclear whether any high-tech company has been successful in
migrating material IP from India. These challenges are also being faced by several
high-tech companies having their headquarters in India.
22 KPMG
in India, Flash News (Dec. 18, 2009), read with Press Note No. 8 (Dec. 16, 2009).
In the past couple

of years, the TPOs
have made significant
transfer pricing
adjustments to the
income of several
multinational
enterprises operating
captive centers in
India, especially in the
areas of technology
and services. Indias
revenue authorities
have also made transfer
pricing adjustments
on account of royalty
and management
fee payouts by
subsidiaries in India of
high-tech companies
headquartered in the
United States and other
parts of the world.
In China, transfer
pricing documentation
is due on May 31 of
the subsequent year,
which is earlier than
deadlines in many
other jurisdictions.
This may force
taxpayers to prepare
documentation for the
other parties to the
transaction earlier to
ensure consistency,
which condenses an
already compressed
compliance calendar.
China
Chinas GDP growth has been impressive, even in a challenging global economy,
resulting in Chinas supplanting of Japan as the worlds second largest economy
in the second quarter of 2010.23 Not surprisingly, increasing numbers of high-tech
companies have expanded into China. Meanwhile, Chinas State Administration of
Taxation (SAT) has invested considerable time and resources in designing its transfer
pricing regime.
On January 8, 2009, Chinas SAT formally issued new transfer pricing regulations.
The new regulations significantly expanded upon the concepts of audit, advance
pricing agreements, and annual filing requirements, as well as introducing
contemporaneous documentation, thin capitalization requirements, and guidelines for
controlled foreign corporations and CSAs.
There has been an increase in efforts by Chinas tax authorities and a renewed focus
on transfer pricing audits. During 2009, the SAT initiated 179 cases and concluded
167, leading to RMB 16.09 billion in income adjustments and RMB 2.09 billion in tax
recovered. This represented a 68.5 percent increase in tax recovered over 2008.
The largest supplementary payment was RMB 461 million, and there were 40 cases
exceeding RMB 10 million (approximately USD 1.5 million), and four cases exceeding
RMB 100 million (approximately USD 15 million).24
Not surprisingly, there are also some unique aspects to Chinas transfer pricing
regime. Like India, China has provided incentives to multinationals to attract inbound
investment. Special tax regimes have been a cornerstone of the incentive program.
It is important to note the specificity of any rulings applied for and received as part of
this program, as such rulings may not cover the natural evolution of operations. For
instance, a tax ruling for research and development activity will not cover back office
services and may not even cover R&D employees providing consulting services.
Further, the rulings are province-specific. Operations in separate locations within
China generally require unique tax rulings and may have different incentives available
to them. Similarly, operations in multiple locations within China are generally not
eligible for a consolidated return as there are many local tax requirements.25
Other aspects of Chinas transfer pricing regime include accelerated documentation
deadlines, currency conversion complexity, and hurdles to IP migration. In China,
transfer pricing documentation is due on May 31 of the subsequent year, which is
earlier than deadlines in many other jurisdictions. This may force taxpayers to prepare
documentation for the other parties to the transaction earlier to ensure consistency,
which condenses an already compressed compliance calendar. With respect to
currency conversion, as the Renminbi (RMB) is not freely floating, there are additional
steps required to repatriate cash from China as well.26 Much like India, movement of
IP out of China is expected to pose challenges to future business restructurings.
Added Enforcement in Japan

Japans tax authority, the National Tax Agency (NTA), has been focusing on the
changes in business environment and issues arising from the hollowing out, a
Japanese term for the general shifting of manufacturing and other sectors to lower
cost jurisdictions, which erodes the economic base in Japan. The Japanese transfer
pricing rules dates back to 1986. Recently, however, transfer pricing rules and
administrative guidelines have been the subject of yearly tax reform. Hollowing
23 China Passes Japan As Second-Largest Economy, ASSOCIATED PRESS, Aug. 16, 2010.
24 Comments obtained from SAT officials during speeches delivered in Beijing on April 23, 2010,
and in Shanghai on November 21, 2009; China Tax News

(www.ctnews.com.cn) on April 12, 2010; Xinhua news; and Interviews with private sources.
25 See KPMG International, Asia Pacific Taxation, China, 2008/09 Edition, at 6 for more information.
26 See KPMG International, Asia Pacific Taxation, China, 2008/09 Edition, at 11 for more information.
out brought about substantial reduction of tangible transactions as significant

manufacturing activity is now performed in lower-cost markets such as China and
Vietnam. Therefore, the recent focus of the tax authority has been on service
transactions, which capture compensation for the headquarter function, and
intangible transactions, which capture compensation for the development of an
intangible. High-tech companies are active participants in this cost optimization trend
as margins have been squeezed by increasing competition and the slow recovery
from the economic downturn. Further, high-tech companies are seeing a shift to
increasing services transactions as business models evolve such as the transition to
software as a service.
In addition, the introduction of major changes in the corporate tax system, particularly
the foreign dividend exclusion in 2009, brought an increased concern by the Japans
tax authority that profits may be shifted from Japan to foreign subsidiaries.
As part of 2010 Tax

Reform, Japans tax
authority announced
changes to their
transfer pricing
documentation
requirements. These
changes are effective
from the fiscal year
starting April 1, 2010.
As part of 2010 Tax Reform, Japans tax authority announced changes to their
transfer pricing documentation requirements. These changes are effective from the
fiscal year starting April 1, 2010.
Article 66-4(7) (now 66-4(6) under the amendment) of the measures known as
Special Provisions for Taxation on Transactions with Foreign Affiliated Persons
(the so-called presumptive taxation provision) vests the tax authorities with the
authority to presume an arms-length price based on, for instance, information
gathered through secret inquiries and inspections on the taxpayers peer
companies and to reassess the taxpayers taxable income in the event the taxpayer
fails to present or submit, without delay, certain information requested by the
transfer pricing examiner during a transfer pricing audit. The information gathered
through such means and used in calculating the presumed arms-length price is
secret, because the tax authorities do not have to disclose this information. It is
confidential under law.
The information required under the prior presumptive taxation provision was only
for books and records (or copies of such) related to the intercompany transactions
under audit. However, under the amended presumptive taxation provision, the
type and coverage of documents and information required are clearly specified,
and are expanded to include detailed information on intercompany transactions and
the transfer pricing methodology adopted in determining the transfer price. These
required documents include similar information required under the transfer pricing
documentation rule in many OECD countries.
2010
2010 KPMG
KPMG International
International Cooperative
Cooperative (KPMG
(KPMG International),
International), aa Swiss
Swiss entity.
entity. Member
Member firms
firms of
of the
the KPMG
KPMG network
network of
of independent
independent firms
firms are
are
affiliated with
with KPMG
KPMG International.
International. KPMG
KPMG International
International provides
provides no
no client
client services.
services. No
No member
member firm
firm has
has any
any authority
authority to
to obligate
obligate or
or bind
bind KPMG
KPMG
affiliated
International
or
any
other
member
firm
vis--vis
third
parties,
nor
does
KPMG
International
have
any
such
authority
to
obligate
or
bind
any
member firm.
firm. All
All rights
rights reserved.
reserved. 32528SVO
32528SVO
member
II. Recent Trends in the

Economic Environment
How Some Governments Have

Addressed Tax Revenue Shortfalls
Australia undertook a comprehensive review of its taxation
system before the extent of the downturn was known. This
review, Australias Future Tax System Review, also known
as the AFTS Review or the Henry Review, published results
in early 2010. The focus of this review is a comprehensive
consideration of tax and transfer (welfare) systems and
international corporate reform.
In the United States, the Obama Administration in early 2009
presented a plan to raise more than $200 billion in new taxes
from multinational companies. According to The Wall Street
Journal, Treasury Secretary Timothy Geithner and Lawrence
Summers, the White House economic adviser, hosted a
conference call on March 25, 2009, with top executives
from several companies, including IBM, Citigroup Inc., GE,
Google Inc. and Honeywell International Inc. to present the
administrations international tax reform proposal. In a May
2009 meeting with a Silicon Valley delegation, Mr. Summers
acknowledged that the government was desperate for new
sources of revenue.27 Essentially, the U.S. government has put
large multinational CFOs on notice that the U.S. Treasury needs
money and intends to seek tax revenue to fill the gap.
In contrast to the United States, the United Kingdom has
adopted a more business-friendly approach. In April 2008, the
U.K. Chancellor of the Exchequer Alistair Darling launched a
high-level forum for multinational senior executives. The thrust
of this forum was to quiet executives fears that international
tax reform in the United Kingdom would endanger their
competitiveness.28 The United Kingdom aims to protect its tax
base by ensuring its largest companies remain headquartered
in the United Kingdom.
27 Neil King Jr. & Elizabeth Williamson, Business Fends Off Tax Hit, WALL ST. J., Oct. 14, 2009.
28 Vanessa Houlder, Treasury Seeks to Reassure Multinationals, FINANCIAL TIMES, Feb. 21, 2010.
Many high-tech companies felt the brunt

of the economic downturn in 2008, but
the recovery began to take hold in 2009.
Although the high-tech recovery appears
to be continuing in 2010, the trajectory
may vary widely among individual
companies and regions.
This recession stands out from other
recent downturns in terms of its severity,
geographic breadth, and impact across
all industries. The recession has led to
persistently high unemployment and
significantly lower tax revenue, both of
which have strained government finances
at a time when economists across the
globe have been calling for government
stimulus packages. As a result, many
governments have identified multinational
corporations as a potential source of
additional tax revenue.
Many government pronouncements may
manifest themselves through changes
in tax law, more rigorous enforcement
efforts, or most likely a combination of
the two. A discussion of the myriad of
possible and proposed tax law changes
are beyond the scope of this paper. The
ultimate impact is expected to be higher
corporate tax payments, particularly for
multinationals, in the near term through
additional tax controversy and in the
longer term by means of revised tax
regimes.
Increased Tax Controversy

As the number and scope of intercompany transactions continue to proliferate in the
expanding global economy, the frequency of transfer pricing-related tax audits had been
increasing, particularly in the high-tech sector, even before the economic downturn.
Penalties and assessments resulting from these audits can be significant. Against the
backdrop of more vigilant taxing bodies around the world, businesses operating in the
global high-tech industry are dealing with the transfer pricing implications growing out
of ongoing mergers and acquisitions, joint ventures, strategic alliances, and corporate
restructurings. In addition to these business combinations, the movement of IP and the
inclusion of stock expense in intercompany services also bring complexity and scrutiny
to high-tech companies. Conflicting positions and methodologies advocated by various
taxing authorities may only serve to increase the amount of resources and the level of
professional and technical judgment needed to determine both the tax position and the
subsequent tax provision.
The main transfer pricing risks for high-tech companies revolve around IP and services.
For example, IP development, use of cross-border consulting, centralized management
services, and intercompany lending services are all intercompany transactions subject
to scrutiny. Contributing to the increased importance of transfer pricing in the high-tech
industry are a number of key elements:
New and expanded transfer pricing legislation in a growing number of countries
Global enforcement and a demand for more thorough documentation relating to
transfer pricing activities
Increasing ranks of government auditors who are well trained in the technical aspects
of transfer pricing
Prevalence of mergers and acquisitions activity and related transfer pricing integration
issues
Importance of stock option grants in employee compensation and their impact on the
cost base for services and the movement of IP
Increasingly common practice of regionally or globally managed business units
Complex issues and transactions resulting from the growing number of jurisdictions
housing tangible property such as plant and equipment, the location of service
providers throughout the organization, and, most importantly, the location and
ownership structure of intellectual property.
The transfer pricing compliance environment has evolved rapidly in a relatively short
period of time. The list of nations that has imposed transfer pricing compliance
requirements continues to grow, and with this phenomenon, there is a new and urgent
focus on multinationals documentation of transfer pricing practices and policies. Hence,
the need for globally consistent processes to create, share, and archive documentation
has become critical.
Hiring Transfer Pricing

Professionals
There was a time in the not-toodistant past when complex
transfer pricing issues might
have been too difficult for some
nations taxing authorities
to evaluate. Now, as a result
of training and experience,
complexity rarely dissuades
taxing authorities from moving
forward and challenging transfer
pricing transactions, which can
result in costly audits.
Helping to accelerate this
long-term trend of increased
transfer pricing scrutiny
is the need for revenue by
cash-strapped governments.
To facilitate this additional
enforcement and fulfill jobs
programs, governments are
hiring rapidly. In 2009, President
Obama, as part of the recently
announced international tax
reform proposals, proposed
to provide the IRS with 800
new staff members to increase
international enforcement.29
In China, the SAT has
been strengthening its
anti-avoidance provisions and
also its anti-avoidance teams.
Companies under audit in China
will face experienced auditors
under pressure to produce
tax revenue, with a growing
array of regulatory options at
their disposal. Transfer pricing
adjustments to taxable income
went from approximately 7
billion RMB in 2005 to more than
16 billion RMB in 2009.30
For additional insights on
transfer pricing controversy, see
KPMG Internationals A Meeting
of MindsResolving Transfer
Pricing Controversies.
To request a copy, e-mail us at
transferpricing@kpmg.com.
29 Press
Release, Office of the Press Secretary, The White House, Leveling

the Playing Field: Curbing Tax Havens and Removing Tax Incentives For
Shifting Jobs Overseas (May 4, 2009), www.whitehouse.gov.
30 Comments obtained from SAT officials during speeches delivered in
Beijing on April 23, 2010; China Tax News (www.ctnews.com.cn) on April 12,
2010; Xinhua news; and Interviews with private sources.

2010
2010 KPMG
KPMG International
Cooperative (KPMG
International), a
a Swiss
Swiss entity.
entity. Member
Member firms
firms of
of the
the KPMG
KPMG network
network of
of independent
independent firms
firms are
are
affiliated
affiliated with
with KPMG
KPMG International.
International. KPMG
KPMG International
provides no
no client
client services.
services. No
No member
member firm
firm has
has any
any authority
authority to
to obligate
obligate or
or bind
bind KPMG
KPMG
International
International or
or any
any other
other member
member firm
firm vis--vis
vis--vis third
third parties,
parties, nor
nor does
does KPMG
KPMG International
International have
have any
any such
such authority
authority to
to obligate
obligate or
or bind
bind any
any
member
member firm.
firm. All
All rights
rights reserved.
reserved. 32528SVO
32528SVO
Countries Imposing Transfer Pricing Rules

This chart reflects the stepped-up enforcement in the global transfer
pricing arena. As many companies that have been subjected to tax
audits can attest, countries no longer act in isolation when it comes
to enforcement of transfer pricing tax matters. In fact, countries that
adhere to OECD transfer pricing guidelines tend to monitor audits
and sanctions imposed by other countries, particularly if those
countries have active tax treaty networks.
2001
2000
1999
1998
1996
1995
<1994
Australia
Czech Republic
France
Germany
Indonesia
Italy
Japan
Poland
Singapore
Slovak Republic
Sweden
United States
Australia
Czech Republic
France
Germany
Indonesia
Italy
Japan
Latvia
OECD
Philippines
Poland
Singapore
Slovak Republic
South Africa
Sweden
United States
Australia
Austria
Czech Republic
France
Germany
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
OECD
Philippines
Poland
Singapore
Slovak Republic
South Africa
Sweden
United States
Argentina
Australia
Austria
Brazil
1997
Australia
Canada
Austria
Chile
Brazil
China (Peoples Republic of)
Chile
Czech Republic
Czech Republic Denmark
France
France
Germany
Germany
Indonesia
Indonesia
Italy
Italy
Japan
Japan
Korea (Republic of) Korea (Republic of)
Latvia
Latvia
Mexico
Mexico
New Zealand
New Zealand
OECD
OECD
Philippines
Philippines
Poland
Poland
Singapore
Singapore
Slovak Republic Slovak Republic
South Africa
South Africa
Sweden
Sweden
Ukraine
Ukraine
United States
United States
Argentina
Australia
Austria
Brazil
Canada
Chile
Czech Republic
Denmark
France
Germany
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Mexico
New Zealand
OECD
Philippines
Poland
Russia
Singapore
Slovak Republic
South Africa
Sweden
Ukraine
United Kingdom
United States
Argentina
Australia
Austria
Brazil
Canada
Chile
Czech Republic
Denmark
Estonia
France
Germany
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Mexico
New Zealand
OECD
Philippines
Poland
Russia
Singapore
Slovak Republic
South Africa
Sweden
Ukraine
United Kingdom
United States
Venezuela
Argentina
Australia
Austria
Brazil
Canada
Chile
Czech Republic
Denmark
Estonia
France
Germany
India
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Mexico
New Zealand
OECD
Peru
Philippines
Poland
Russia
Serbia
Singapore
Slovak Republic
South Africa
Sweden
Ukraine
United Kingdom
United States
Venezuela

2010
2010 KPMG
KPMG International
Cooperative (KPMG
International), a
a Swiss
Swiss entity.
entity. Member
Member firms
firms of
of the
the KPMG
KPMG network
network of
of independent
independent firms
firms are
are
affiliated
affiliated with
with KPMG
KPMG International.
International. KPMG
KPMG International
provides no
no client
client services.
services. No
No member
member firm
firm has
has any
any authority
authority to
to obligate
obligate or
or bind
bind KPMG
KPMG
International
International or
or any
any other
other member
member firm
firm vis--vis
vis--vis third
third parties,
parties, nor
nor does
does KPMG
KPMG International
International have
have any
any such
such authority
authority to
to obligate
obligate or
or bind
bind any
any
member
member firm.
firm. All
All rights
rights reserved.
reserved. 32528SVO
32528SVO
2008/2009
2007
2006
2005
2004
2003
2002
Argentina
Australia
Austria
Brazil
Canada
Chile
Czech Republic
Denmark
Estonia
France
Germany
India
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Luxembourg
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Russia
Serbia
Singapore
Slovak Republic
South Africa
Sweden
Thailand
Ukraine
United Kingdom
United States
Venezuela
Argentina
Australia
Austria
Brazil
Canada
Chile
Czech Republic
Denmark
Estonia
France
Germany
Hungary
India
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Luxembourg
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Russia
Serbia
Singapore
Slovak Republic
South Africa
Sweden
Thailand
Ukraine
United Kingdom
United States
Venezuela
Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Czech Republic
Denmark
Estonia
France
Germany
Hungary
India
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Lithuania
Luxembourg
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Romania
Russia
Serbia
Singapore
Slovak Republic
South Africa
Sweden
Taiwan (Republic of China)
Thailand
Ukraine
United Kingdom
United States
Venezuela
Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Czech Republic
Denmark
Ecuador
Egypt
Estonia
France
Germany
Hungary
India
Indonesia
Italy
Japan
Korea (Republic of)
Latvia
Lithuania
Luxembourg
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Romania
Russia
Serbia
Singapore
Slovak Republic
Slovenia
South Africa
Sweden
Thailand
Ukraine
United Kingdom
United States
Venezuela
Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Czech Republic
Denmark
Ecuador
Egypt
Estonia
France
Germany
Hungary
India
Indonesia
Israel
Italy
Japan
Korea (Republic of)
Latvia
Lithuania
Luxembourg
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Romania
Russia
Serbia
Singapore
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Thailand
Ukraine
United Kingdom
United States
Venezuela
Vietnam
Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Czech Republic
Denmark
Ecuador
Egypt
Estonia
Finland
France
Germany
Greece
Hong Kong
Hungary
India
Indonesia
Ireland (Republic of)
Israel
Italy
Japan
Korea (Republic of)
Latvia
Lithuania
Luxembourg
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
OECD
Peru
Philippines
Poland
Portugal
Romania
Russia
Serbia
Singapore
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Switzerland
Thailand
Turkey
Ukraine
United Kingdom
United States
Venezuela
Vietnam
Argentina
Aruba
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Croatia
Czech Republic
Denmark
Ecuador
Egypt
Estonia
Finland
France
Germany
Greece
Hong Kong
Hungary
India
Indonesia
Ireland (Republic of)
Israel
Italy
Japan
Kazakhstan
Kenya
Korea (Republic of)
Latvia
Lithuania
Luxembourg
Malawi
Malaysia
Mexico
Montenegro
Netherlands
New Zealand
Norway
OECD
Peru
Philippines
Poland
Portugal
Romania
Russia
Serbia
Singapore
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Switzerland
Thailand
Turkey
Ukraine
United Kingdom
United States
Venezuela
Vietnam
Zambia
Economic Downturn and Uncertain Timing of Recovery

By now, many high-tech companies believe they have seen the worst of the
downturn and are either anticipating or beginning to return to profitability.31 Given
the impetus of the downturn, a global financial crisis, and its severity, the recovery
is expected to be less robust than recoveries from the tech bubbles of the 1990s.
Historically, recessions associated with financial crises have been deeper, longer
lasting, and followed by slower recoveries.32
In April 2010, the International Monetary Fund (IMF) projected that global economic
activity contracted by 0.6 percent in 2009 and would grow by 4.2 percent in 2010.
The IMF projections are significantly weaker for the advanced economies (including
the United States, the United Kingdom, the Euro area, Canada, and Japan): a
3.2 percent decline in 2009 and 2.3 percent growth in 2010. IMF projections for
developing Asia are relatively better, calling for 6.6 percent growth in 2009 and
8.7 percent growth in 2010. After growing at 2.8 percent in 2008, and declining
at 10.7 percent in 2009, world trade volume is expected to grow at 7 percent in
2010.33 More recent economic indicators have been mixed, with some economists
predicting a double-dip recession in major markets.34
The documentation
required in one
jurisdiction of a
transaction affected
by the global
downturn may
be very different
from that needed
to substantiate
the transaction in
another. Analyses
prepared in these
circumstances will
require careful
consideration of
attribution of risk,
adjustments to
comparable results,
and consideration of
loss splits.
The global economic recession has led to lower profits and/or losses for a number
of high-tech companies. Some companies may not have anticipated the lower
profits and/or losses when their transfer pricing policies were established. Further,
many high-tech companies have undertaken significant cost-reducing and other
restructurings, whose treatment for transfer pricing purposes must be carefully
considered. Tax authorities in jurisdictions where losses are recorded may challenge
the substance behind the assumption of risk leading to the losses. Clearly written
intercompany agreements can be very helpful in this regard; other factors typically
considered by the tax authority include whether the entity had decision-making
authority matching the risks assumed and the financial capacity to bear the resulting
outcomes.35
Documenting and sustaining transfer pricing in this economic environment can create
many difficult issues for tax departments. While the problems may be particularly
acute for a high-tech company facing system losses that must be recognized
somewhere, volatility and uncertainty of profits and prices can affect transfer pricing
even at profitable companies. For example, the documentation required in one
jurisdiction of a transaction affected by the global downturn may be very different
from that needed to substantiate the transaction in another. Analyses prepared
in these circumstances will require careful consideration of attribution of risk,
adjustments to comparable results, and consideration of loss splits.
As companies file their tax returns and prepare transfer documentation for 2009,
high-tech companies are paying particular attention to the treatment of items related
to the recession, such as the recognition of losses and restructuring charges.
31 KPMG LLP United States, TECHNOLOGY INDUSTRY EXECUTIVE SURVEY (July 2010).
32 INTERNATIONAL MONETARY FUND (IMF), WORLD ECONOMIC OUTLOOK: CRISIS AND RECOVERY 98 (Apr. 2009).
33 All projections cited are from IMF World Economic Outlook, supra note 32, table 1.1.
34 Stiglitz Says European Economy at Risk of Double-Dip Recession, BLOOMBERG NEWS, Aug. 24, 2010; Simon Constable,
Potential for Double Dip Recession, WALL ST. J., Aug. 28, 2010.
35 Treas. Reg. 1.482-1(d)(3)(iii)(B).
Economist Shiller Sees
Recognition of Losses
When a high-tech company as a whole, or a line of business within the broader
group, experiences losses, transfer pricing policies help determine how those losses
are recognized among the various legal entities. Many tax authorities, themselves
under pressure to maintain tax revenue collections, are likely to assert that the
burden of losses should fall outside their own jurisdictions.
More specifically, transfer pricing policies help determine how business risks are
shared within the group. As a simple example, suppose the group manufactures
products in one country and sells to controlled distributors abroad. As a result of the
recession, the end user price may have fallen sharply. If the transfer pricing policy
is based on a fixed price paid to the manufacturer, then the distributor is bearing
the entire burden associated with the price reductions. If, alternatively, the transfer
pricing policy sets the unit price so the distributor earns an arms-length profit, then
much of the burden of the price reduction is passed back to the manufacturer.
Many high-tech companies have implemented transfer pricing policies that treat
most of their subsidiaries (not just distributors) as limited risk entities with targeted
operating margins. In such cases, nearly the entire burden of declines in both
price and unit volume may fall on a single central entrepreneur. The consolidated
group may pay taxes in many jurisdictions despite system losses; the resulting tax
inefficiency will be particularly large if the central entrepreneur is located in a low-tax
jurisdiction or faces other restrictions on future tax benefits associated with these
losses.
High-tech companies in this position may consider changes to these structures.
However, changes to the allocation of risk must be done before the fact. Tax
authorities may consider attempts to allocate risks ex post to be inconsistent with
the arms-length principle. Such ex post allocations of risk will likely receive increased
scrutiny from tax authorities.
Many high-tech
companies have
implemented transfer
pricing policies that
treat most of their
subsidiaries (not just
distributors) as limited
risk entities with
targeted operating
margins. In such cases,
nearly the entire burden
of declines in both price
and unit volume may
fall on a single central
entrepreneur.
Restructuring
In response to the economic downturn, many high-tech companies took preemptive
action to control costs and cash at the outset of the recession. These actions may
have included significant reductions in force, facility closings or consolidations, and
even exiting certain markets. These restructurings frequently included reorganization
of responsibilities and decision-making authority within the company.
The arms-length
principle generally
requires that
attribution of risk
be aligned with the
capacity to bear
and manage that
risk. Restructurings
in which the key
decision-making
authority is removed
fromor moved
intolegal entities
should be reflected
in revised transfer
pricing policies.
The arms-length principle generally requires that attribution of risk be aligned with
the capacity to bear and manage that risk. Restructurings in which the key decisionmaking authority is removed fromor moved intolegal entities should be reflected
in revised transfer pricing policies.
Business restructurings often result in nonrecurring charges, such as severance
costs and/or impairment charges, being recorded on financial statements. The
treatment of such charges for transfer pricing purposes is often not obvious. In
some cases, restructuring charges and/or other cost variances can interact with a
companys transfer pricing policy in ways that make little sense. Should severance
charges associated with a significant reduction in force be included in the cost base
for cost plus entities? The inclusion of restructuring charges in the cost base may
result in increases in profits and taxes even when economic conditions suggest that
profits should fall.
If the restructuring has a material impact on the current periods profitability or future
potential for earnings, the high-tech company must also consider whether an exit
charge is appropriate or would be deemed appropriate by the local taxing authority.
In evaluating the treatment of these charges, the key factors are to determine what
entity benefits from the restructuring, what the intercompany agreement says, and
whether the resulting financial outcomes make sense. Such issues are likely to be
viewed differently by the tax authorities on the charging and receiving ends of the
transaction, and careful thought and documentation of the facts and circumstances
supporting the treatment chosen is highly recommended.
Cash is king became a popular phrase during the course of the economic
downturn. Managing the cash in a high-tech multinational became more challenging
as there was generally less cash available. For many high-tech companies, this cash
constraint was a new challenge after many years of significant cash build-up from
successful IPOs, other offerings, and growing profitability.
One mechanism for managing cash is related-party loans. Related-party debt

warrants review during any economic shock. Of particular concern is whether the
one party fails to follow the stated terms of a loan agreement. For example, the
lender may waive loan covenants or permit the borrower to skip a payment during a
cash crunch. Such lapses may result in a tax authority asserting that the debt is not
bona fide indebtedness, attempting to recharacterize it as equity.36 Alternatively, the
lender and borrower may significantly modify the terms of a loan and fail to realize
that they have created a new debt instrument.37 In this case, the old transfer pricing
documentation would no longer apply, and the arms-length nature of the new loan
would have to be documented using contemporaneous transactions.38 Given the
volatility in the credit markets, previous rates and terms may be difficult to defend
and should be carefully examined.
Major economic and regulatory developments in 2009 that may have created
a variety of transfer pricing issues for high-tech companies have increased the
importance of ongoing examination of unusual profit results and restructuring
items. While many high-tech companies are on the road to recovery and some are
experiencing record revenues and profits, it may be appropriate to invest the time
and resources to document the basis for these restructuring items. It will be critical
for transfer pricing documentation to clearly articulate the business factors behind
the financial results as well as demonstrate how the treatment of unusual items is
consistent with transfer pricing policies and agreements.39
Major economic
and regulatory
developments in 2009
that may have created
a variety of transfer
pricing issues for
high-tech companies
have increased the
importance of ongoing
examination of unusual
profit results and
restructuring items.
36 Laidlaw Transp., Inc., v. Commissioner, T.C. Memo. 1998-232, 75 T.C.M. (CCH) 2598 (1998).
37 See Treas. Reg. 1.1001-3.
38 Treas. Reg. 1.482-2(a).
39 See additional insights on transfer pricing in the current economic environment, in KPMG Internationals
Planning for the Recovery Examining Transfer

Pricing in the Current Environment and Beyond, 2009. To request a copy, e-mail us at transferpricing@kpmg.com.
III. Recent Trends in the

Business Environment
The functions and

risks of all parties to
the intercompany
transactions as well
as the character of
the income arising
from the transactions
will need to be
reviewed and perhaps,
reconsidered.
Conversion to Fabless Chip Companies

The current prevailing mode for chip design companies is to be fabless. For
those with fabs, several have expanded their third-party fab production. Notably,
Advanced Micro Devices (AMD) sold its semiconductor fabrication facilities (fabs)
into a joint venture with Advanced Technology Investment Company, a sovereign
wealth fund wholly owned by the Emirate of Abu Dhabi in 2009. The joint venture,
GLOBALFOUNDRIES, assumed ownership of all AMDs fabs, in an effort to
increase profits by lowering the cost model.40 AMDs chief competitor, Intel, is so
far bucking this trend and keeping production in-house. In 2009, Intel decided to
invest US$7 billion in refurbishing its semiconductor fabrication plants in the United
States.41 Intel believes that keeping production in-house provides a comparative
advantage, because the company has direct control over processes, quality control,
product cost, volume, timing of production, and other factors.42 Other major chip
makers with primarily outsourced production include , Altera, Atheros, LSI Logic,
NVidia, and Xilinx, among others.
While decisions about whether to manufacture in-house or through third parties
are driven by business considerationsi.e., cost, capacity, turnaround time,
investment, protection of manufacturing IP, etc.the tax and transfer pricing
impact of such changes must be evaluated as part of the overall cost benefit
analysis. The selection of a new manufacturer can cause changes in the entire
supply chain. The functions and risks of all parties to the intercompany transactions
as well as the character of the income arising from the transactions will need to be
reviewed and, perhaps, reconsidered. For business models where a related-party
manufacturer was the entrepreneur, significant support for the remaining activities
in that jurisdiction will be required.
40 Ed
Sperling, Why AMDs Arab Joint Venture Matters, FORBES,

Mar. 9, 2009.
41 Id.
42 Intel Corp., Annual Report (Form 10-K) (fiscal year ending Dec.
27, 2008), at 11.
43 Mark LaPedus, Intel to Build New 300-mm Fab in Arizona, EE
TIMES, July 25, 2005
44 Press Release, David Lammers, Semiconductor Intl, Toshiba
Plans Two Memory Fabs (Feb. 19, 2008); Press Release, David
Lammers, Semiconductor Intl, SanDisk, Toshiba Announce Flexible
MOU (Feb. 19, 2008).
For chip companies, investment in fabs is generally the single largest tangible
investment. A new fab can cost up to US$7 billion. In 2005, a new fab in the United
States cost US$3 billion to build.43 In 2008, a new fab in Japan was expected to
exceed JPY 700B (US$6.6 billion at the time of announcement).44 The cost of the
fab varies based on wafer size (i.e.,, a 300mm fab) and the process dimension
(i.e., a 43 nm process) as well as the location of the facility. In shifting to a fabless
company, the balance sheet will be materially different. Additional consideration as
to relevant business metrics and profit level indicators (PLIs) will be necessary to
appropriately evaluate and test transactions.
One defining characteristic of the high-tech industry is that nothing is static. As

significantly as the hardware business model has changed in recent years, the
software model has evolved in kind.
Software as a Service and Cloud Computing

Software was originally resident on mainframe computers. In the 1980s, with the
birth of client servers and desktop computers, software existed on the server as
well as desktops and was portable on discs and other media. With increasingly
mobile workforces, software needs to be accessed from a bevy of new
devices such as laptops, netbooks, and smartphones. Installing and maintaining
software on each device is a resource-intensive process. Accordingly, software
is increasingly being offered as a service, meaning that it is hosted by another
party, often the software provider, and accessed by various customer devices.
Cloud computing is an extension of this trend in which software applications are
accessed via the Internet in a manner that is generally dynamically scalable, and the
responsibility for maintenance and support is abstracted from the user.
This evolution of the software industry has unique implications for tax and
transfer pricing. Instead of to be or not to be, the eternal question is: What is
it? In other words, is it tangible property, IP, or a service? Or is it all of the above?
This characterization dilemma has been present since the emergence of the
software industry. However, recent trends in customer delivery and use have
added new complexity and variability. Notably, software is increasingly distributed
electronically either for download or online use. The fact that the delivery of the
software has been decoupled from the physical media moves it one step away
from a tangible property transaction and that much closer to IP, or a service.
Software made available to customers from cloud computing is one level more
abstract from the original physical media. Still, the characterization determination is
highly fact-specific and similar transactions may, in fact, have different characters.
In this potential bundle of IP and services, one must clearly establish the nature
of the transaction for a host of tax reasons. In the United States, one must also
determine what transfer pricing methods apply, i.e., Treas. Reg. section 1.482-4
or Treas. Reg. section 1.482-9.45 Under the OECD guidelines, only one set of
methods applies regardless of character of income. Nonetheless other tax issues
may be triggered, e.g., VAT, withholding, and customs. Further, this determination
of license versus service may impact revenue recognition. While the accounting
treatment is not controlling for the tax treatment or vice versa, it is important for
both the tax and accounting teams to understand each others factual basis for their
determination.
Depending on the specific contract, the same software may be a sale/license of
property in one instance and a service in another. This poses challenges from a
transfer pricing perspective. Factual development is necessary to assess whether
the functions and risks are sufficiently different to warrant separate pricing
mechanisms or different profit outcomes.
This trend to electronic transmission of software also generates nexus issues.
Specifically, which jurisdiction has the right to tax the transaction? Is it the country
where the server is located or the country where the customer uses the software?
Again, specific factual development is necessary to make this determination.
From a transfer pricing perspective, the key is to determine which entities are party
to the transaction. Regardless, cloud computing makes this determination even
more complex.
45 Treas.
Reg. 1.6662-6(d)(3).
Cloud computing
is an extension of
this trend in that
software applications
are accessed via the
Internet in a manner
that is generally
dynamically scalable,
and the responsibility
for maintenance and
support is abstracted
from the user.
If software is stored and retrieved from the cloud, which jurisdiction governs? There
is considerable lack of clarity in existing regulations and guidance, so intercompany
agreements should be very clear as to where the software and related IP is owned
and the specific nature of distribution rights. This specificity could also drive clarity in
customer agreements as well.
In addition to jurisdiction issues, companies should also consider timing issues.
Are intercompany payments triggered by the contribution of software to the cloud
or delivery/access from the cloud? Again, it may be important to confer with the
accounting team on the facts pertinent to revenue recognition and customer payment
in determining the timing of intercompany payments.
In general, an APA may make sense in situations where there is little regulatory
guidance and room for interpretation of value. However, the very multilateral nature of
cloud computing and the presence of low tax jurisdictions in the cloud may complicate
the effectiveness of the APA process.
Changes to Revenue Recognition

Any material change in accounting policy has the potential to impact transfer pricing.
Revenue recognition is one area of evolving accounting policy. One of several key
differences between U.S. Generally Accepted Accounting Principles (GAAP) and
International Financial Reporting Standards (IFRS) relates to the recognition of revenue.
In addition to
jurisdiction issues,
companies should also
consider timing issues.
Are intercompany
payments triggered
by the contribution of
software to the cloud
or delivery/access
from the cloud?
The Financial Accounting Standards Boards (FASBs) Emerging Issues Task Force
(EITF) recently reached two Consensuses affecting revenue recognition. The first
Consensus (EITF 08-01)46 requires a vendor to allocate revenue to each unit of
accounting in many arrangements involving multiple deliverables based on the relative
selling price of each deliverable. It also changes the level of evidence of stand-alone
selling price required to separate deliverables by allowing a vendor to make its best
estimate of the stand-alone selling price of deliverables when more objective evidence
of the selling price is not available. The second Consensus (EITF 09-03) 47 excludes
sales of tangible products that contain essential software elements from the
scope of revenue recognition requirements for software arrangements. Due to these
changes, revenue will be recognized earlier for many revenue transactions involving
multiple deliverables and for sales of software-enabled devices.
The FASB ratified these Consensuses on September 23, 2009. Accounting Standards
Updates (ASUs) 2009-13 48 and 2009-14 49 amend FASB Accounting Standards
Codification (ASC) for EITF 08-01 and EITF 09-03. The ASC is now the exclusive
authoritative reference for non-governmental U.S. GAAP for use in financial
statements for interim and annual periods ending after September 15, 2009.
EITF 08-01 can be applied on a prospective basis or in certain circumstances
on a retrospective basis. If prospective adoption is elected, it is to be applied to
arrangements entered into or materially modified in fiscal years beginning on or after
June 15, 2010. Earlier adoption is permitted. If an entity elects early adoption on a
prospective basis and the period of adoption is not the beginning of the reporting
entitys fiscal year, the requirements are applied retrospectively to the beginning of the
fiscal year. Entities that early adopt at an interim period with retrospective application
to the beginning of the year would be required to disclose, at a minimum, the changes
46 EITF Issue No. 08-1, Revenue Arrangements with Multiple Deliverables, available at www.fasb.org.
47 EITF Issue No. 09-3, Certain Revenue Arrangements That Include Software Elements, available at www.fasb.org.
48 FASB Accounting Standards Update No. 2009-13, Revenue Recognition (Topic 605)-Multiple-Deliverable Revenue Arrangements,
available at www.fasb.org.
49 FASB Accounting Standards Update No. 2009-14, Software (Topic 985)-Certain Revenue Arrangements That Include Software Elements,
available at www.fasb.org.
from the retrospective application on revenue, income before taxes, net income,
earnings per share, and the effects of the change for the appropriate captions
presented in those previously reported interim periods.
As companies adopt either the new U.S. GAAP standard or convert to IFRS from
their local country GAAP, the impact of the change in revenue recognition on
intercompany payments should be thoughtfully considered.
For many high-tech companies, changing to the new U.S. GAAP standards or IFRS
is appealing as companies have greater discretion in how they recognize revenue,
which may often lead, at least in the near term, to more comparable financial
statements. When significant differences in accounting policy are present, one
must consider the impact on comparability. As the adoption of these new revenue
recognition standards unfolds, it may, in the short term, impact the comparability of
financial statements among companies in the same market. As will be demonstrated
below, the profit outcomes may become widely variable at the outset of adoption.
High-tech companies may need to carefully review the adoption status of potentially
comparable companies when using a profit-based transfer pricing methodology such
as the comparable profits method (CPM).
Such changes may impact more than the testing of transfer pricing policy; they
may also impact the execution of transfer pricing policies. In general, if the existing
deferred revenue rolls off naturally, i.e., is recognized over time as originally intended
from an accounting standpoint, then the transition issues, from a transfer pricing
perspective, are generally forward-looking. The calculation or timing of subsequent
intercompany payment may need to be modified to be consistent with third-party
pricing or profitability results.
If the existing deferred revenue is accelerated or never recognized because
the revenue recognition treatment is retroactively applied, then the impact on
intercompany payments should be considered. For example, an electronics device
company under its old revenue recognition policy recognized US$300 in revenue
ratably over three years because of an ongoing three-year post-delivery customer
support obligation for which objective and reliable evidence of fair market value did
not exist.
For many high-tech

companies, changing
to the new U.S.
GAAP standards or
IFRS is appealing
as companies have
greater discretion in
how they recognize
revenue, which may
often lead, at least in
the near term, to more
comparable financial
statements.

2010
2010 KPMG
KPMG International
Cooperative (KPMG
International), a
a Swiss
Swiss entity.
entity. Member
Member firms
firms of
of the
the KPMG
KPMG network
network of
of independent
independent firms
firms are
are
affiliated
affiliated with
with KPMG
KPMG International.
International. KPMG
KPMG International
provides no
no client
client services.
services. No
No member
member firm
firm has
has any
any authority
authority to
to obligate
obligate or
or bind
bind KPMG
KPMG
International
International or
or any
any other
other member
member firm
firm vis--vis
vis--vis third
third parties,
parties, nor
nor does
does KPMG
KPMG International
International have
have any
any such
such authority
authority to
to obligate
obligate or
or bind
bind any
any
member
member firm.
firm. All
All rights
rights reserved.
reserved. 32528SVO
32528SVO
Original Revenue Recognition for Year 1 Contract

Period
Year 1
Year 2
Year 3
Revenue
100
100
100
Costs
90
90
90
Profit
10
10
10
Taxes at 30 percent
If the intercompany agreement determines payments based on the accounting

treatment, then payment for this sale in year 1 is drawn out evenly over three years
(see chart). Now suppose that in year 2, the accounting standards change such that
a greater portion of the revenue from a new agreement would be recognized in the
first year of the agreement, as shown in the following table.
Revenue Recognition under New Policy for Year 2

Contract
Period
Year 1
Year 2
Year 3
Year 4
Revenue
250
25
25
Costs
230
20
20
Profit
20
Taxes at 30 percent
1.5
1.5
Then one must consider what happens to the deferred revenue related to the
arrangements accounted for under the old guidance. If the new guidance is adopted
retrospectively, then the financial statements for prior periods are restated to reflect
the new policy for all periods presented. However, there may not be a trigger in
the intercompany agreement to recomputed intercompany balances subsequent
to restatements. In this instance, the related party would recognize additional
revenues of US$150 in year 1 in the restated financial statements that may not
trigger an intercompany payment. This result makes little sense. If the intercompany
agreement provides no guidance, the parties to the transaction must agree to a
reasonable solution.
Revenue Recognition of Year 1 and Year 2 Contract

with Retrospective Adoption
Period
Year 1
Year 2
Year 3
Year 4
Revenue
250
275
50
25
Costs
230
250
40
20
Profit
20
25
10
Taxes at 30 percent
7.5
1.5
Taxing authorities will likely resist a change in year 2 that results in an additional
US$150 of revenue in year 1 without a corresponding increase in taxable revenue. If
this additional US$150 revenue were to be picked up in year 2 for tax purposes, then
the erratic profit result widens further.
Period
Year 1
Year 2
Year 3
Year 4
Revenue
100
425
50
25
Costs
90
390
40
20
Profit
10
35
10
Taxes at 30 percent
10.5
1.5
High-tech companies would be advised to consider the tax and transfer pricing
impact of retrospective application of changes in accounting policy to manage these
types of nonsensical and highly variable profit outcomes.
For more information that analyzes the new standards and addresses many other
implementation issues that a high-tech firm may encounter, please see KPMG LLPs
publication Issues In-Depth, Implementing the New EITF Consensuses on Multiple
Element Revenue Arrangements, October 2009, No. 0-03.50
50 http://us.kpmg.com/microsite/attachments/us_accounting_bulletin_2009/issues-in-depth-09-3--implementing-the-New-EITF-consensuses-revenue.pdf.
Conclusion
As the business outlook for the high-tech sector has improved significantly, the
outlook for tax and transfer pricing controversy remains challenging. Governments
are likely to place increased emphasis on fiscal responsibility and bringing budgets
into balance as any recovery takes hold. While stimulus money will diminish,
increased tax receipts will be a necessary lever in this balancing act. It is anticipated
that both corporate tax reform and more rigorous global tax enforcement will
contribute to government revenue.
With tax scrutiny at potentially an all-time high, high-tech companies should seek
to address a range of issues for which reasonable minds could determine different
outcomes, such as treatment of losses, renegotiation of internal and external
agreements, attribution of profit, and restructuring charges. In this period of change,
high-tech companies are expected to be particularly turbulent since their industry
is among the most rapidly evolving. Particular care should be taken to establish the
business factors leading to any unusual outcome and reconcile treatment to existing
intercompany arrangements. Given the multiyear nature of many transfer pricing
methodologies and of tax audits, issues arising from this economic shock will remain
relevant for the foreseeable future.
KPMG: Experienced Teams

KPMGs Information, Communications & Entertainment (ICE) professionals offer
skills, insights, and experience culled from our firms experiences of working
with technology companies to deliver the services you need to help you succeed
wherever you compete in the world. We offer audit, tax, and advisory services that
focus on addressing your most pressing business requirements. KPMGs network of
highly qualified professionals in member firms in the Americas, Europe, the Middle
East, Africa, and Asia Pacific can help you reduce costs, mitigate risk, improve
controls over a complex value chain, protect intellectual property, and meet the
myriad challenges of the digital economy.
Authors
This paper was written by Global Transfer Pricing professionals Tamara Gracon and
David Houston, with insights from Yoko Hatta, Cheng Chi, and Rohan Phatarphekar.
Contributors
In addition, we would like to thank the following people who contributed to the
production of this white paper: David Crosswy, Danny Dentone, Kevin Davidson,
Bruce Hager, Federica Marchesi, Sheafali Patel, Maryia Poli, Matt Powers, Patricia
Rios, and Anne Welsh (KPMG in the U.S.).
Contact Us
For more information about this publication, or about KPMGs Information,
Communications & Entertainment practice and high-tech industry capabilities, please
contact the following practice leaders:
Global
Rusty Thomas
Partner
KPMG in the U.S.
Silicon Valley, California
+1 650 404 5008
rcthomas@kpmg.com
Anne Welsh
Principal
KPMG in the U.S.
Seattle, Washington
+1 206 913 4132
awelsh@kpmg.com
US/North America
Tamara Gracon
Managing Director
KPMG in the U.S.
+1 650 404 4705
tgracon@kpmg.com
Margaret Critzer
Principal
KPMG in the U.S.
+1 650 404 4932
mcritzer@kpmg.com
Steve Felgran
Principal
KPMG in the U.S.
New York, NY
+1 212 872 6799
sfelgran@kpmg.com
Mary Furlin
Partner
KPMG in Canada
Ontario, Canada
+1 416 228 7202
mfurlin@kpmg.ca
Europe
David Houston
Director
KPMG in Ireland
Dublin, Ireland
+35 317 004233
david.houston@kpmg.ie
Matthias Kaut
Partner
KPMG in Germany
+49 211 475 7390
mkaut@kpmg.com
Jan Martens
Partner
Fidal*
La Defense, France
+33 (1) 5568 1618
jmartens@fidalinternational.com
Eduard Sporken
Director
KPMG in The Netherlands
Amstelveen, Netherlands
+31 (0) 20 656 16 18
sporken.eduard@kpmg.nl
Markus Wyss
Partner
KPMG in Switzerland
Zurich, Switzerland
+41 44 249 24 72
mwyss@kpmg.com
Asia Pacific
Yoko Hatta
Partner
KPMG in Japan
Tokyo, Japan
+81 (3) 6229 8350
yoko.hatta@jp.kpmg.com
Rohan Phatarphekar
Executive Director
KPMG in India
Mumbai, India
+91 (22) 30902000
rohankp@kpmg.com
Cheng Chi
Partner
KPMG in China
Shanghai, China
+86 (21) 2212 3433
cheng.chi@kpmg.com.cn
Tony Gorgas
Partner
KPMG in Australia
Sydney, Australia
+61 (2) 9335 8851
tgorgas@kpmg.com.au
* FIDAL is an independent
legal entity that is separate
from KPMG International and
its member firms.
As e-mail addresses and phone numbers change frequently, please e-mail us at transferpricing@kpmg.com if you are unable to contact an individual via the information noted above.

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INFORMATION, COMMUNICATIONS & ENTERTAINMENT

Transfer Pricing Topics for

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG

Considerations for Acquisitions

U.S. Regulatory Developments

U.S. Final Services Regulations and Cost Sharing Regulations 10

India and China Enforcement

Added Enforcement in Japan

II. RECENT TRENDS IN THE ECONOMIC ENVIRONMENT

Increased Tax Controversy

Economic Downturn and Uncertain Timing of Recovery

Conversion to Fabless Chip Companies

Software as a Service and Cloud Computing

Changes to Revenue Recognition

This white paper aims to

4 Transfer Pricing Topics for High-Tech Companies

Transfer Pricing Topics for High-Tech Companies 5

The significance of transfer

I. The Current Transfer

Transfer pricing and

Transfer Pricing Topics for High-Tech Companies 7

As companies outlooks improve, many companies will seek growth through

IP and Transfer Pricing

The following checklist, while not

Considerations for Acquisitions

Transfer Pricing Checklist for

in New York City (Jan. 26,

Where will restructuring costs be

For many companies, the complexity of managing distributed IP ownership from a

8 Transfer Pricing Topics for High-Tech Companies

Transfer Pricing Topics for High-Tech Companies 9

One of the key takeaways is

U.S. Regulatory Developments

As high-tech companies migrate functionality to geographic clusters, two common

Temporary Cost Sharing Regulations

10 Transfer Pricing Topics for High-Tech Companies

Transfer Pricing Topics for High-Tech Companies 11

12 Treas. Reg. 1.482-7T(k)(4).

OECDs New Guidelines

Perhaps the most

12 Transfer Pricing Topics for High-Tech Companies

Transfer Pricing Topics for High-Tech Companies 13

The purported contractual allocation of risk between associated enterprises being

While the new

India and China Enforcement

14 Transfer Pricing Topics for High-Tech Companies

Transfer Pricing Topics for High-Tech Companies 15

In the past couple

16 Transfer Pricing Topics for High-Tech Companies

Added Enforcement in Japan

and in Shanghai on November 21, 2009; China Tax News

out brought about substantial reduction of tangible transactions as significant

As part of 2010 Tax

II. Recent Trends in the

How Some Governments Have

18 Transfer Pricing Topics for High-Tech Companies

Many high-tech companies felt the brunt

Transfer Pricing Topics for High-Tech Companies 19

Increased Tax Controversy

Hiring Transfer Pricing

Release, Office of the Press Secretary, The White House, Leveling

20 Transfer Pricing Topics for High-Tech Companies

Countries Imposing Transfer Pricing Rules