ADIT Transfer Pricing Module Brochure

TRANSFER PRICING
OPTION
Contents
• What you’ll cover and what you’ll gain
• Recommended ways to prepare for your exam
• June 2018 exam questions
• June 2018 exam answers
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GLOBAL
CHALLENGING
PRACTICAL
VALUED
RECOGNISED
ADVANCED
UP-TO-DATE
STRUCTURED
FLEXIBLE
EMPOWERING
RENOWNED
SPECIALIST
THOROUGH
CURRENT
INTERNATIONAL
MODERN
UNIQUE
GLOBAL
ADVANCED
2 ADIT
Transfer Pricing option
What you’ll cover and what you’ll gain
The Transfer Pricing module is one of fourteen elective modules available to ADIT students. Introduced to
the ADIT syllabus in 2011, it has become one of the most popular options among ADIT students including
in-house tax practitioners working for large corporate firms. One of four thematic modules offered, it
covers the fundamentals of transfer pricing based on the OECD model.
What you’ll cover

The Transfer Pricing module gives candidates a strong foundation in this key topic in international
taxation. Key topics include:
• The Arm’s Length principle
• Functional analysis
• Transfer pricing methods
• Comparability
• Specific transactions
• Permanent establishments
• Compliance issues
• Avoiding double taxation and dispute resolution
What you’ll gain

• A thorough grounding in transfer pricing theory in the international context
• A robust understanding of theory coupled with practical application giving you the confidence to
apply principles to your daily work
• Up to date knowledge of fast-changing developments in tax law as exams are regularly updated to
cover current tax laws and emerging trends
ADIT 3
Syllabus
I Fundamental sources 15%

II The Arm’s Length Principle (ALP) 5%
III Functional analysis 10%
IV Transfer pricing methods 10%
V Comparability 10%
VI Specific transactions 15%
VII Permanent Establishments (PEs) 10%
VIII Compliance issues 5%
IX Avoiding Double Taxation and dispute resolution 10%
X Other issues 10%
I Fundamental sources
A Tax treaties, based on the OECD Model Convention and UN Model Double Tax Convention,
specifically Article 9 and “special relationship” in Articles 10-12 3
B OECD 2017 Transfer Pricing Guidelines (TPG) 3
C OECD BEPS 2015 Final Reports (Actions 8-10) : Aligning Transfer Pricing Outcomes with Value Creation 2
D UN 2017 Practical Manual on Transfer Pricing for Developing Countries 3
E Transfer pricing litigation cases (refer to the reading list) 3
F EUJTPF Codes of Conduct guidelines and reports 2
II The Arm’s Length Principle (ALP)
A Interpretation of the arm’s length principle and current dialogue 3

B Associated enterprises 3
C Global Formulary Apportionment 1
D Recognition of the actual transactions undertaken 2
E Losses and the effect of government policy 2
III Functional analysis
A Goal of functional analysis 1

B Analysis of functions, assets and risks (FAR) 3
C Relating functional analysis to selection of transfer pricing method 3
D Entity characterisation (e.g. characterisation as “entrepreneur”, stripped risk manufacturer,
commissionaire, etc.) 2
E Practical approach to undertaking functional analysis 3
IV Transfer pricing methods
A Description of methods 2
B Selection and application of the method(s) (including by reference to FAR analysis, entity
characterisation and availability of comparables); the party to be tested 3
4 ADIT
Syllabus
V Comparability
A Significance of comparability and factors determining comparability 3

B Performing a comparability analysis 3
C Dealing with the lack of comparable data 2
D Sources of information: internal/external comparables; “secret comparables”, foreign comparables 2
E Timing and compliance issues in comparability 2
VI Specific transactions
A Intra-group services
1. Different types of intra-group services 3
2. Transfer pricing methods 3
3. Direct/indirect charging and allocation keys 3
4. International guidelines on reviewing services 2
B Intra-group financial transactions
1. Intragroup loans, credit guarantee fees, factoring or receivables, cash pooling, and other forms
of financing and credit risk transfer arrangements 3
2. Loan pricing including creditworthiness, interest rates and credit margins 2
3. Thin capitalisation rules and the nexus with Transfer Pricing 3
4. Debt pricing and/or debt amounts that result in ongoing losses or low levels of profitability 2
C Intangible property
1. The life cycle of intangibles (development, exploitation, exit strategy) 1
2. Different types of intangibles 2
3. Models to structure the development of intangibles (e.g. contract research and development
vs. cost contribution/cost sharing arrangements) 3
4. Models for exploiting intangibles: for example principal structure vs. licensing out 3
5. Valuation of intangible assets 3
6. Current developments on transfer pricing aspects of intangibles 2
D Business restructurings
1. The nature of business restructuring 1
2. Guidance on transfer pricing aspects of business restructurings including Chapter IX of the OECD TPG) 3
E Cost Contribution Arrangements/Agreements
1. Concept of a CCA including entry, withdrawal or termination 3
2. Applying the ALP in a CCA 3
3. Tax consequences if a CCA is not arm’s length 1
4. Structuring and documenting a CCA 2
VII Permanent Establishments (PEs)
A Article 5 Permanent Establishments (OECD and UN Models) 1

B Article 7 Business Profits (OECD and UN Models) 2
C Understanding the importance of PEs when dealing with transfer pricing 3
VIII Compliance issues
A Documentation 3
1. OECD BEPS 2015 Final Reports (Action 13) 3
2. Country by country reporting, master and local file documentation formats 3
B Examination practices, burden of proof and penalties 2
C Risk assessment and risk management 3
D Audits 1
ADIT 5
Syllabus
IX Avoiding Double Taxation and dispute resolution
A Adjustments 3
B Mutual agreement procedure, including OECD BEPS 2015 Final Reports (Action 14) 3
C Arbitration Article 25(5) 2
D EU Arbitration Convention 1
E Advance Pricing Agreements 3
X Other issues
A Base Erosion and Profit Shifting project 3

B Interaction between customs valuation and transfer pricing 2
C Safe harbours and tax incentives 2
D E-commerce and transfer pricing 2
E Worldwide recent developments in transfer pricing 2
6 ADIT
Recommended ways to prepare for the exam
Course Provision OECD, Committee on Fiscal Affairs. Transfer Pricing

Guidelines for Multinational Enterprises and Tax
There are study options to suit everyone, from Administrations (Paris: OECD, 2017)
classroom learning to self-study. Whatever your [ISBN: 9789264262737]
preference, you’ll find a method and providers that Available from the OECD: www.oecd-ilibrary.org
work for you. Find out more at Or available from Turpin Distribution:
www.adit.org.uk/courses ebiz.turpin-distribution.com
Tolley Exam Training. ADIT International Materials for

Permitted Texts 2018 (LexisNexis, 2018)
Available from LexisNexis:
Candidates may take a copy of the following texts into examtraining@lexisnexis.co.uk
the examination:
United Nations. UN Model Double Taxation Convention
OECD, Committee on Fiscal Affairs. Model Tax between Developed and Developing Countries 2017.
Convention on Income and on Capital (Paris: OECD, (New York: UN, 2017) [ISBN: 9789211591026]
2017) [ISBN: 9789264287945] and accompanying Available from the United Nations: www.un.org
Commentary: Article 5, Article 7, Article 9, and “special
relationship” in Articles 10-12 United Nations. UN Practical Manual on Transfer Pricing
Available from the OECD: www.oecd-ilibrary.org for Developing Countries (2017) (New York: UN, 2017)
Or available from Turpin Distribution: Available from the United Nations: www.un.org
ebiz.turpin-distribution.com
Van Raad, K. Materials on International, TP and EU Tax
OECD, Committee on Fiscal Affairs. OECD/G20 Base Law 2018-2019. Volume A (Leiden: International Tax
Erosion and Profit Shifting Project 2015 Final Reports. Centre, 2018) [ISBN: 9789082585414]
Actions 8-10 (Paris: OECD, 2015) Candidates with a pre-2016 edition may instead take
[ISBN: 978 9264241237] Volume 1 of the earlier edition into the examination.
Available from Turpin Distribution: Available from the International Tax Centre at Leiden
ebiz.turpin-distribution.com University:
www.itc-leiden.nl or b.bosman@itc-leiden.nl
OECD, Committee on Fiscal Affairs. OECD/G20 Base Or available from Wildy & Sons: www.wildy.com
Erosion and Profit Shifting Project 2015 Final Reports.
Action 13 (Paris: OECD, 2015) [ISBN: 978 9264241466]
Available from Turpin Distribution: Essential Reading
Yong, S.S.T. The Logic and Practice of Transfer Pricing
OECD, Committee on Fiscal Affairs. Report on the (LexisNexis, 2014) [ISBN: 9789814406789]
Attribution of Profits to Permanent Establishments Available from LexisNexis:
(Paris: OECD, 2010) https://store.lexisnexis.com.sg
Available from the OECD: www.oecd-ilibrary.org
Or available from Turpin Distribution:
ADIT 7
Additional Reading Case Law

Collier R. and Andrus JL, Transfer Pricing and the Arm’s The following court decisions:
Length Principle After BEPS (OUP, 2018) • Chevron Australia Holdings Pty Ltd v Commissioner
Available from OUP: global.oup.com of Taxation [2017 FCAFC 62]
• DSG [2009 UKFTT 31 (TC)]
Van Raad, K. Materials on International, TP and EU Tax
Law 2018-2019. Volume B (Leiden: International Tax • GE Capital [2010 FCA 344]
Centre, 2018) • GSK Canada [2010 FCA 201]
Available from the International Tax Centre at Leiden • Ireland/Apple state aid [SA.38373]
University:
• LG Electronics India Pvt Ltd v ACIT [2013 29
www.itc-leiden.nl or b.bosman@itc-leiden.nl
Or available from Wildy & Sons: www.wildy.com taxmann.com 300]
• Roche Products Property [2008 AATA 261]
EY. EY Worldwide Transfer Pricing Reference Guide • Netherlands/Starbucks state aid [SA.38374]
2017-2018 (EY, 2017)
• SNF (Australia) Pty Ltd v Commissioner of Taxation
Available from EY:
[Single Federal Court Decision, 2010 FCA 635]
www.ey.com
• SNF (Australia) Pty Ltd v Commissioner of Taxation
The following texts may also be considered useful [Full Federal Court Decision, 2011 FCAFC 74]
for candidates in understanding the post-BEPS • Unilever Kenya [Income Tax Appeal 753 of 2003]
environment. However, familiarity with these texts is
not required to sit and pass the exam:
Websites
Lolliri, F. Transfer Pricing Risks Post-BEPS: a Practical
Guide (LexisNexis, 2017) [ISBN: 9780754554639] EU Joint Transfer Pricing Forum:
Available from LexisNexis: http://ec.europa.eu/taxation_customs/taxation/
https://store.lexisnexis.co.uk (Discount available for company_tax/transfer_pricing/forum/index_en.htm
registered ADIT students using discount code 100672)
Candidates should read the following sections:
Lang, M., Petruzzi, R. and Storck, A. Transfer Pricing
Developments Around the World 2017 (Kluwer Law 1. Background, Achievements
International, 2017) [ISBN: 9789041183750] 2. Code of conduct on transfer pricing documentation
Available from Wildy & Sons: www.wildy.com for associated enterprises in the EU
3. Guidelines for Advance Pricing Agreements (APAs)
OECD. Additional Guidance on the Attribution of Profits in the EU
to a Permanent Establishment (OECD 2018) 4. Guidelines on low-value-adding intra-group services
Available from OECD: www.oecd.org 5. Potential approaches to non-EU triangular cases
6. Report on Small and Medium Enterprises (SMEs)
OECD. Guidance on the implementation of Country-by- and Transfer Pricing
Country Reporting (OECD 2018) 7. Report on Cost Contribution Arrangements on
Available from OECD: www.oecd.org Services not creating Intangible Property (IP)
8. Report on Secondary Adjustments
OECD. Guidance on the appropriate use of information 9. Report on Transfer Pricing Risk Management
contained in CbC Reports (OECD 2018) 10. Report on Compensating Adjustments
Available from OECD: www.oecd.org
8 ADIT
OECD BEPS page:

www.oecd.org/ctp/beps.htm
OECD Transfer Pricing page:

www.oecd.org/ctp/tp
Candidates should read documents relevant to the
syllabus within the “What’s New” and “Transfer Pricing
Projects” sections.
Pacific Association of Tax Administrators (PATA) Transfer

Pricing Documentation Package:
www.ustransferpricing.com/PATA_
transferpricingpackage.pdf
United Nations: www.un.org/esa/ffd

Candidates should read documents relevant to the
syllabus within the “Transfer Pricing” and “BEPS”
thematic areas.
ADIT 9
June 2018 examination questions
Transparent and accessible past papers Other papers available

Real questions and answers from previous exams
PRINCIPLES OF INTERNATIONAL TAXATION
are available to ADIT students to help with their
study. Practice with previous exams helps students AUSTRALIA INDIA
become familiar with the format of the exam,
identify areas for further study and focus on exam BANKING IRELAND
technique.
BRAZIL MALTA
CHINA SINGAPORE
CYPRUS TRANSFER PRICING
EU DIRECT TAX UNITED KINGDOM
EU VAT UNITED STATES
HONG KONG UPSTREAM OIL & GAS
10 ADIT
THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION
June 2018
MODULE 3.03 – TRANSFER PRICING OPTION

ADVANCED INTERNATIONAL TAXATION
(THEMATIC)
TIME ALLOWED – 3¼ HOURS
This exam paper has three parts: Part A, Part B and Part C.
You need to answer five questions in total.
You must answer:

 Both questions in Part A (25 marks each)
 One question from Part B (20 marks)
 Two questions from Part C (15 marks each)
Further instructions
 All workings should be made to the nearest month and in appropriate monetary currency,
unless otherwise stated.
 Start each answer on a new page and clearly indicate which question you are answering.
If you are using the on-screen method to complete your exam, you must provide
appropriate line breaks between each question, and clearly indicate the start of each new
question using the formatting tools available.
 Marks are specifically allocated for presentation.
 The time you spend answering questions should correspond broadly to the number of
marks available for that question. You should therefore aim to spend approximately half
of your time answering Part A, and the other half answering Parts B and C.
 The first 15 minutes of the exam consists of reading time. You will be allowed to annotate
the question paper during this time; however, you will not be permitted to start writing or
typing your answer. The Presiding Officer will inform you when you can start answering
the questions.
 Although references and short quotes from the OECD Transfer Pricing Guidelines
can be included in your answer, you will not benefit from any extra marks by
copying from the OECD Transfer Pricing Guidelines directly.
Module 3.03 – Transfer Pricing option (June 2018)
PART A
You are required to answer BOTH questions from this Part.
The following facts apply to both Questions 1 and 2
The Global Dash Cam Group (GDC) is a multinational group headquartered in Country A by
ParentCo. ParentCo has a small office with approximately ten employees engaged in logistics,
purchasing and invoicing functions, including its chief executive officer and board members.
GDC’s core business is the manufacture and sale of motor vehicle dashboard cameras.
ParentCo has a subsidiary, Dash Cam 1 (DC1), which is resident in Country B and performs a
contract manufacturing function. DC1 purchases high quality raw materials from Dash Cam 2
(DC2), a related party resident in Country C, and a slightly lower grade of raw materials from
Cam Components (CC), an independent party resident in Country D. DC1 manufactures two
brands of camera, Dashcam Delux and Dashcam Standard, using the raw materials purchased
from DC2 and CC respectively.
GDC uses a related party distributor, Dash Cam 3 (DC3), and an independent party distributor,
Cam Supplier 1 (CS1), to sell the final products to third party end customers in Country E. DC3
and CS1 are both resident in Country E, and possess warehouses in which their respective
products are stocked prior to sale. DC3 assumes warranty, product liability and foreign
exchange risk while CS1 does not.
ParentCo previously owned all intellectual property, including trademarks, relating to Dash Cam
products sold in Country E. However, ParentCo has recently transferred this intellectual
property to DC4, a related party, resident in a lower tax jurisdiction (Country F). It is unknown
how many staff, if any, are employed by DC4.
DC3 pays a royalty to ParentCo for the use of the tradename on the products distributed in
Country E, but CS1 does not. This royalty became payable to DC4 upon transfer of the
intellectual property and the royalty rate (percentage of sales) was increased, on the basis that
DC3 is distributing a higher quality product which may command a premium price in Country E
in comparison to the product distributed by CS1.
DC3 and CS1 both perform intensive marketing and sales functions in Country E in building the
brand and market share for the products sold.
Dash Cam 5 (DC5), resident in Country G, performs routine administrative, information systems
management and human resources functions on behalf of ParentCo and other affiliates. It is
unknown how many staff, if any, are employed by DC5.
There exist a number of competitors selling similar products to those distributed by CS1 and
DC3 in Country E.
Following extensive research and development conducted by DC4 and ParentCo, a new
dashboard camera product has recently been developed. DC4 and ParentCo have entered into
a cost sharing arrangement relating to the intellectual property developed and patented for this
new product. It is anticipated that ParentCo will contract the manufacture of the new product to
DC1, and then sell it in Country A.
GDC has recently begun selling the Dashcam Delux and Dashcam Standard online to
customers of Country E, booking all sales in Country A in ParentCo’s name.
Page 2 of 7
1. You have been approached by the Tax Manager of the GDC Group, to provide transfer
pricing advice in relation to the arrangements described opposite.
You are required to:
1) Perform a functional analysis for the GDC Group and discuss practical
approaches to the undertaking of a functional analysis. (15)
2) Explain how you would characterise each of the entities within the GDC
Group. (5)
3) Discuss any potential transfer pricing issues in relation to the OECD BEPS
2015 Final Reports (Actions 8-10) which may be relevant to the GDC Group.
(5)
Total (25)
2. You are required to:
1) Discuss each of the OECD recommended transfer pricing methods in

relation to the GDC Group, highlighting the relative strengths and
weaknesses of each method with regard to the arm’s length principle. (15)
2) Explain the significance of a comparability analysis, and discuss how this

may be applied to the GDC Group. Discuss any issues or other factors to be
considered with regard to comparability. (10)
Total (25)
Page 3 of 7
PART B
You are required to answer ONE question from this Part.
3. The Bonnie Group (Bonnie) is a multinational group of companies which is a market

leader in the premium hair dye business.
Bonnie’s parent company (Bonnie Corp) is based in Country A, in which until recently it
undertook research and development (owning all group intellectual property),
manufactured all of the group’s products for sale around the world, prepared all
marketing materials to provide to subsidiaries, provided technical expertise to
subsidiaries, and made sales in Country A. Bonnie Corp also sold finished product to five
subsidiaries based in different countries. The corporate income tax rate in Country A is
38%.
Bonnie recently engaged a global adviser to implement a supply chain transformation

project. The project was implemented a year ago, with the following material changes
made to the Bonnie group:
 A new subsidiary (Sub Z) was established in Country Z and instructed to undertake

all manufacturing for the Bonnie Group, including the sale of finished products to
Bonnie Corp and five additional related companies.
 Sub Z legally acquired all intellectual property, including manufacturing know how,
patents, trademarks and marketing material. No consideration was paid by Sub Z.
 Bonnie Corp provided funds, on an interest-free basis, to Sub Z in order to finance

the construction of a new manufacturing facility.
 A small number of key operational staff in the areas of manufacturing, research

and development, global marketing and technical experts relocated to Country Z
and became employees of Sub Z.
 Bonnie Corp’s manufacturing operations in Country A were shut down, with most
of the plant and equipment scrapped.
 Bonnie Corp’s senior management team and Board of Directors remained based
in Country A and employed by Bonnie Corp.
As a result of this business restructure, Bonnie Corp incurred significant staff redundancy
costs which contributed to a significant loss recorded by Bonnie Corp in Country A during
the first year following the implementation of the project. Bonnie Corp is now classified
as a low risk distributor.
Sub Z made a significant profit in its first year of operation. The income tax rate in Country
Z is 15%.
You are a transfer pricing auditor in Country A and have recently begun a compliance
audit of Bonnie Corp.
1) Identify the key transfer pricing issues and risks relating to the above
activities. (15)
2) Advise what an arm’s length outcome would be for the tax administration of
Country A, regarding Bonnie Corp’s business restructure with reference to
the OECD guidelines. (5)
Total (20)
Page 4 of 7
4. Albo Corp (Albo) is a company resident in Ardalia, and will shortly commence business
operations in Bothland through the establishment of a branch. Albo manufactures cigar
products in Ardalia, and will sell these products through its Bothland branch to
independent customers based in Bothland.
A Double Taxation Agreement (DTA) exists between Ardalia and Bothland, based on the
OECD Model Tax Convention. Both countries also have transfer pricing legislation based
on the OECD Transfer Pricing Guidelines.
Two options for the implementation of the proposed arrangement are currently under
consideration by Albo:
1) Option 1: Profits derived from the sale of products through the branch in Bothland
will be treated as profits belonging to Albo. An income tax return will not be lodged
in Bothland.
2) Option 2: The branch will be treated as a separate legal entity in Bothland, and
Albo will set the transfer price of the cigars charged to the branch as the cost of
manufacture to Albo plus an uplift of 7.5%. This will result in a guaranteed profit to
the Bothland branch in relation to the sale of cigars.
1) Explain, in your own words, the concept of a ‘branch’ or ‘permanent

establishment’, including how the transfer pricing provisions will apply. (7)
2) Which of the above options would you recommend to Albo’s management

board? In your response, you should refer to any relevant provisions of the
DTA that might apply, with explanation of how the provisions relate to each
option, and explain how any transfer pricing rules will apply to the options
proposed. (13)
(Total 20)
Page 5 of 7
PART C
You are required to answer TWO questions from this Part.
5. You are the taxation adviser to the Pineapple Group, a multinational group which carries
out business in multiple jurisdictions.
Pineapple’s directors have asked you to provide written responses to the following
questions:
1) What is an Advanced Pricing Arrangement (APA)? Outline the benefits of an

APA for the Pineapple Group. (3)
2) Are all members of the Pineapple Group required to enter into an APA? (2)
3) What impact is the OECD’s Base Erosion and Profit Shifting (BEPS) initiative
likely to have, in relation to a new APA for the Pineapple Group? (4)
4) In what circumstances can the Pineapple Group request Mutual Agreement

Procedures (MAP)? (3)
5) If an APA is in place, will this reduce the likelihood of the Pineapple Group
securing a future MAP? (3)
Total (15)
6. You are required to produce a report on the following transfer pricing matters:
1) Explain the concept of a transfer pricing ‘safe harbour’, with specific

reference to its practical application and including a specific example. (5)
2) Explain why Country by Country documentation is important, from a tax

administration’s perspective. (5)
3) Advise why is it important for a multinational group to prepare good quality

contemporaneous transfer pricing documentation? (5)
Total (15)
7. Your international tax partner has asked you to develop advice for a new multinational
client operating in the pharmaceutical industry.
1) Explain each of the following concepts, which are both means to develop
Intellectual Property:
a) Contract research and development; and (4)
b) A cost contribution arrangement or cost sharing arrangement. (4)
2) Describe, in your own words, the concept of the ‘arm’s length principle’, and
what this means from a practical perspective, including appropriate
references. (7)
Total (15)
Page 6 of 7
8. The following cases have been cited as examples of important decisions in the practice
of transfer pricing:
 GSK Canada [2010 FCA 201]

 Netherlands/Starbucks state aid [SA.38374]
 Ireland/Apple state aid [SA.38373]
You are required to choose one of these cases, and explain:
1) The applicable facts of the case;
2) The issue which was contested;
3) The decision made by highest court deciding the case; and
4) Any broader implications which have arisen from the decision. (15)
9. You are reviewing the file of Sargent Ltd, a large multinational company, in your role as
a Tax Officer. You have a risk hypothesis that the large volume of tax losses recorded
by the group is largely the result of tax planning through intra-group financial
transactions.
Upon further examination and exchanges of information with other tax administrations,
there may be some instances in which Sargent is not paying tax in multiple jurisdictions
due to various financing arrangements involving hybrids. Some of the transfer pricing
documentation notes significant intra-group loans with different currencies, various
financial instruments, use of credit rating analyses and a cash pooling arrangement.
There is also an analysis having regard to intra-group financing and thin capitalisation.
1) Discuss the potential transfer pricing issues in relation to the intra-group

financing of Sargent Ltd. (10)
2) Discuss potential intra-group financing transfer pricing risks for Sargent

Ltd, with to relevant OECD Base Erosion and Profit Shifting (BEPS) Project
action items. (5)
Total (15)
Page 7 of 7
THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION
June 2018
MODULE 3.03 – TRANSFER PRICING OPTION
SUGGESTED SOLUTIONS
PART A
Question 1
Part 1 & 2
In undertaking a functional analysis of the GDC group, reference is made to the OECD Transfer
Pricing Guidelines 2017, Chapter I, D.1.2
GDC Functions Assets Risks Characterisation

Group
ParentCo Management Intellection Property Market Entrepreneur,

Logistics (tradename) Credit intellectual
Procurement Human capital Foreign property owner,
Invoicing Office exchange head office
Intellectual
property protection
and maintenance
DC1 Contract Plant and equipment Market Contract

Manufacturing Know how Inventory Manufacturer
Logistics Human capital Product
Office liability
Capacity
DC2 Distribution of raw Human capital Market Low risk
materials Office distributor
Sales Warehouse
Logistics
Invoicing
DC3 Distribution of raw Human capital Market Low risk

materials Office Product distributor
Sales Warehouse Warranty
Marketing Customer lists Foreign
Logistics exchange
Invoicing
CS1 Distribution of raw Human capital Market Low risk

Sales Warehouse
Marketing Customer lists
Logistics
Invoicing
CC Distribution of raw Human capital Market Low risk

Sales Warehouse
Marketing
Logistics
Invoicing
DC4 Research and Human capital (to be Market Research and

Development determined) Research development
Intellectual Office (to be and provider,
property protection determined) development entrepreneur,
and maintenance Intellectual property intellectual
property owner
DC5 Provision of Human capital Market Services provider
administrative, Office
Page 2 of 28
information
systems and
human resources
services
A practical functional analysis will involve conducting functional interviews with personnel
across all areas of the business, including the operational level. Questions will be aimed at
understanding how the various business divisions interact within the company onshore and
offshore. The roles and responsibilities of the personnel will be understood as well as decision
making, communication, business strategy and risks borne. The global value chain is required
to be understood and the interaction of the various entities within it. The value created by each
of the entities is important as well as the legal rights and obligations of each of the parties in
performing the functions. The functional analysis seeks to identify the economically significant
activities and responsibilities undertaken, assets used or contributed, and risks assumed by the
parties to the transactions. The analysis focuses on what the parties actually do and the
capabilities they provide.
Part 3
 Implications in relation to the OECD BEPS Project, Actions 8 – 10 (Aligning Transfer

Pricing Outcomes with Value Creation) may include:
 Arm’s-length pricing should be based on accurately delineated transactions.
 Analysis of the contractual relations together with evidence of the actual conduct of the
parties, including control over risks.
 Where economically relevant characteristics of a transaction are inconsistent with
contractual terms, the actual transactions should in general be identified based on the
actual conduct of the parties
 The legal form of the transaction relative to the economic reality of the transaction.
 As part of the functional analysis of GDC Group, the transfer of intellectual of property
must be examined. In this regard, the legal and economic ownership requires
consideration for the transaction between ParentCo and DC4 within the group. This
has implications for the royalty being paid also and the beneficial owner of the
intellectual property.
 Valuation issue in relation to the arm’s length compensation for transfer of intellectual
property from ParentCo and DC4.
 Ownership of intangibles and transaction involving the development, enhancement,
maintenance, protection and exploitation of intangibles.
- Economic substance relative to legal form of the research and development
activities conducted by DC4 and ParentCo in the context of the cost sharing
arrangement.
 An examination of operating profit allocation to the entities within GDC Group to the
economic activities generating them.
Page 3 of 28
Question 2
Part 1
Reference is made to the OECD Transfer Pricing Guidelines 2017, Chapter II, Transfer Pricing
Methods, Part II: Traditional transaction methods:
 Comparable uncontrolled price method (CUP):

 The CUP method compares the price charged for property or services transferred in a
controlled transaction to the price charged for property or services transferred in a
comparable uncontrolled transaction in comparable circumstances. If there is any
difference between the two prices, this may indicate that the conditions of the
commercial and financial relations of the associated enterprises are not arm’s length,
and that the price in the uncontrolled transaction may need to be substituted for the
price in the controlled transaction.
 An uncontrolled transaction is comparable to controlled transaction for the purposes of
a CUP if a) None of the differences (if any) between the transactions being compared
or between the enterprises undertaking those transactions could materially affect the
price in the open market; or b) reasonably accurate adjustments can be made to
eliminate the material effects of such differences. Where it is possible to locate
comparable uncontrolled transactions, the CUP method is the most direct and reliable
way to apply the arm’s length principle.
 A CUP method is particularly reliable where an independent enterprise sells the same
product as is sold between two associated enterprises. However, it does require a high
degree of comparability.
 For the GDC group, there is a potential internal CUP for the price paid by DC1 to –
comparing the price paid by DC1 to DC2 with the price paid by DC1 to CC.
 Resale price method:
 The resale price method begins with the price at which a product has been purchased
from an associated enterprise and the product is resold to an independent enterprise.
This price (the resale price) is then reduced by an appropriate gross margin on this
price (the “resale price margin”) representing the amount out of which the reseller would
seek to cover selling and other operating expenses, and in light of the functions
performed (taking into account the assets used and risks assumed), make an
appropriate profit. What is left after subtracting the gross margin can be regarded, after
adjustment for other costs associated with the purchase of the product (eg. customs
duties), as an arm’s length price for the original transfer of property between the
associated enterprises. This method is probably most useful where it is applied to
marketing operations.
 The resale margin of the reseller in the controlled transaction may be determined by
reference to the resale price margin that the same reseller earns on items purchased
and sold in comparable uncontrolled transactions (“internal comparable”). Also, the
resale price margin earned by an independent enterprise in comparable uncontrolled
transactions may serve as a guide (“external comparable”).
 Resale price method is difficult to apply in terms of gaining gross margin data and also
requires no alteration to the product resold.
 For the GDC group, a resale price method could potentially be applied in relation to the
margins of the distributors (resellers) in the group being DC2, DC3, CS1 and CC.
 Cost plus method:
 The cost plus method begins with the cost incurred by the supplier of property (or
services) in a controlled transaction for property transferred or services provided to an
associated purchaser. An appropriate cost plus mark-up is then added to this cost, to
make an appropriate profit in light of the functions performed and the market conditions.
What is arrived at after adding the cost plus mark up to the above costs may be
regarded as an arm’s length price of the original controlled transaction. This method
probably is most useful where semi-finished goods are sold between associated
parties, where associated parties have concluded joint facility agreements or long-term
buy-and-supply arrangements, or where the controlled transaction is the provision of
services.
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 For the GDC group, DC5 may be remunerated on a cost plus basis, applying a an arm’s
length margin to the cost base of chargeable services. Also, DC1 as a contract
manufacturer may be remunerated using a cost plus method.
 Transactional net margin method:
 The ‘TNMM’ examines the net profit relative to an appropriate base (eg. costs, sales,
assets) that a taxpayer realises from a controlled transaction. Thus, the TNMM
operates in a similar manner to the cost plus and resale price methods. A functional
analysis of the controlled and uncontrolled transactions is required to determine
whether the transactions are comparable and what adjustments may be necessary to
obtain reliable results. A strength in includes that the net profit indicators are less
affected by transactional differences than is the case with price, as used by the CUP
method. Also, net profit indicators may be more tolerant to some functional differences
between the controlled and uncontrolled transactions than gross profit margins. As with
any one-sided method, it is necessary to examine a financial indicator for only one the
associated enterprises (the tested party) which is a benefit when one of the entities to
the transaction are complex and has many interrelated activities or lack of information.
Weaknesses include being influenced by some factors that would either not have an
effect, or have a less substantial or dire t effect, on price or gross margins between
independent parties. Also requires information on uncontrolled transactions that may
not be available at the time of the controlled transactions as well as may not having
enough specific information on profits attributable to controlled transactions including
operating expenses. Net profit indicators may also be affected by forces operating in
the industry.
 Refer to section B.3.2 for further detail on selection of the net profit indicator.
 In terms of the GDC group, a TNMM may be applied to the entities with a distribution
function given there is are potential comparable. An EBIT/Sales PLI may be appropriate
in this regard.
 Transactional profit split method:
 The profit split method seeks to eliminate the effect on profits of special conditions
made or imposed in a controlled transaction by determining the division of profits that
independent enterprises would have expected to realise from engaging in the
transaction. Can also be losses split. Splits those combined profits or losses between
the associated enterprises on an economically valid basis per an arm’s length
agreement. A main strength is that it can offer a solution for highly integrated operations
for which a one-sided method would not be appropriate. Also, when both parties may
be found to make valuable contributions to the transaction and therefore a two-sided
method is more appropriate. If this is not the case, then it would not be appropriate.
Less likely that either party to the controlled transaction will be left with an extreme or
improbable profit result. A weakness is in the application in terms of accessing
information for offshore affiliates and to identify the operating expenses to allocate.
 Approaches for profit split – contribution analysis (refer to section C.3.2.1) and residual
analysis (refer to section C.3.2.2).
 In terms of the GDC group, a profit split method may be applied between the activities
of ParentCo and DC4.
It is noted that the ‘most appropriate method’ must be applied. The CUP, RPM and Cost Plus
are all traditional transactional methods while the TNMM and PS methods are profit based
methods.
Part 2
Refer to Chapter III – Comparability Analysis.
In considering whether controlled and uncontrolled transactions are comparable, regard should
be had to the effect on price of broader business functions other than just product comparability
– ie. The economically relevant characteristics or comparability factors relevant to determining
comparability (that need to be identified in the commercial or financial relations between the
associated enterprises in order to accurately delineate the actual transaction) including:
- The contractual terms of the transaction (refer D.1.1);
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- The functions performed by each of the parties to the transaction, taking into
account assets used and risks assumed, including how those functions relate to
the wider generation of value by the MNE group to which the parties belong, the
circumstances surrounding the transaction, and industry practices (refer D.1.2);
- The characteristics of property transferred or services provided (refer D.1.3);
- The economic circumstances of the parties and of the market which the parties
operate (refer D.1.4); and
- The business strategies pursued by the parties.
 This information about the economically relevant characteristics of the actual

transaction should be included as part of the local file as described in Chapter V in
support of a taxpayer’s analysis of its transfer pricing.
 In terms of the GDC group, regard must be given to Chapter III of the OECD Transfer
Pricing Guidelines (2017). The comparability factors listed above will require careful
consideration in the context of each method potentially selected and applied. For
example, differences with CUP application in terms of the characteristics of the product
(difference in quality), markets operating in, the contractual terms of any intra-group
agreements (such as long-term supply agreements and distribution agreements). The
FAR of the independent entities potentially comparable and to be used for a set should
be analysed in applying a TNNN or Profit Split
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PART B
Question 3
Part 1
A business restructure has been undertaken. Reference is made to the July 2017 OECD
Transfer Pricing Guidelines, Chapter IX – Transfer Pricing Aspects of Business Restructurings.
Key issues and risks are as follows:
 Disposal/sale of IP by Bonnie Corp to Sub Z for no consideration. An independent party

would seek to be compensated either through a capital amount or alternatively licence
payment (this is dependent on the facts of the case).
 Bonnie Corp has incurred costs in staff redundancies and ending manufacturing
operations. An independent party would seek to be compensated.
 Bonnie has loaned funds to Sub Z – a third party would seek to be compensated at an
arm’s length interest rate.
 Bonnie has made a loss in the first year of operation of new business model. New
subsidiary was established in country Z, called Sub Z.
 Sub Z may not be compensating Bonnie Corp for use of the IP, management fees and
other services.
 Functional analysis of both Bonnie and Sub Z pre and post BR would need to be
undertaken.
 Sub Z undertakes all manufacturing for the Bonnie group including selling finished
product to Bonnie Corp and five additional related companies.
 Sub Z legally acquired all intellectual property (including manufacturing know how,
patents, trademarks and marketing material). No consideration was paid by Sub Z.
 Bonnie Corp provided funds interest free to Sub Z to construct a new manufacturing
facility.
The following sections are relevant (not exhaustive):
 B: Applying Article 9 of OECD Convention. Under Article 9, requirement to determine

if the conditions made or imposed in a BR differ from conditions that would be made
between independent enterprises (para 9.9).
 Part 1:Arm’s length compensation for the restructuring itself.
- A Introduction: The first step is to accurately delineate the transactions that
comprise the BR by identifying commercial or financial relations and the conditions
attached to those relations that lead to the transfer of value (para 9.10)
- B. Understanding the restructuring: No different to usual transfer pricing
transactions.
• Requires an examination of the economically relevant characteristics of the
commercial or financial relations between the associated enterprises, and in
particular the contractual terms of the business restructuring (Section D.1.1);
• The functions performed by each party to the restructuring, before and after
the restructuring, taking into account assets used and risks assumed (Section
D.1.2);
• The economic circumstances of the parties (Section D.1.4)
• Business strategies (Section D.1.5). The analysis reviews the business
reasons for and the expected benefits from the restructuring, including the role
of synergies, and the options realistically available to the parties.
 Part B.4: Transfer pricing documentation for business restructurings. MNE groups
should document their decisions and intentions regarding BR’s, especially their
decisions to assume or transfer significant risks, before the transactions occur, and
document the evaluation on profit potential (para 9.33).
 Part D.1 Profit potential. The arm’s length principle does not require compensation for
a mere decrease in the expectation of an entity’s future profits. However, where
something of value or termination, independent parties would compensate.
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 Part E.2: Intangibles. Transfers of intangibles or rights in intangibles raise difficult

questions both as to the identification of the intangibles transferred and as to their
valuation (para 9.55).It will be affected by a number of factors including the amount,
duration and riskiness of the expected benefits, the nature of the intangible right etc
(para 9.56).
 Part E.2.1 Disposal of intangibles to a central location.
Part 2
With regard to the above references, Country A would want to ensure that Bonnie Corp was
remunerated for the transfer of valuable intangibles to Sub Z. Further, Bonnie Corp should not
be in a loss position in the first year following the BR. Compensation may need to be provided
by Sub Z to Bonnie Corp in relation to the shutdown of manufacturing operations and staff
redundancies if Bonnie no longer has the opportunity to exploit the IP. This is especially the
case if Bonnie Corp has disposed of key assets and is no longer subject to significant risks.
The functionality of Bonnie Corp appears to be significantly reduced post restructure.
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Question 4
Part 1
Article 5 of the OECD Model Tax Convention should be considered to determine if a PE or

branch exists.
The concept of a PE or branch determines the right of a tax administration to tax the profits of
an enterprise of another jurisdiction. Under Article 7 (Business profits), this cannot happen
unless it carries out its business through a PE.
According to Article 5, for a PE to exist there must be:
a) place of management
b) a branch
c) an office
d) a factory
e) a workshop
f) a mine, oil or gas well, quarry or other place of extraction of natural resources
g) a building site or construction or installation project if more than 12 months
A PE will not exist in these instances:
a) Maintenance of facilities for storage, display or delivery of goods/merchandise

b) Maintenance of goods/merchandise for:
 Storage, display or delivery
 processing by another entity
 purchasing goods or collecting information
Transfer pricing rules apply irrespective if a transaction involves a company and its branch in
another country/jurisdiction. Therefore, a PE or branch should be treated as if it were an
independent enterprise and ensure that it receives an arm’s length return.
Part 2
Option 1 is not acceptable to Bothland as this would result in no income being returned despite
economic activity.
Option 2 is an example of the cost plus transfer pricing method demonstrating the best method
and that a 7.5 % mark-up was adequate by reference to comparable transactions between
unrelated parties (subject to documentation and comparability studies confirming).
Overlapping mechanisms can apply – the DTA and the domestic Transfer Pricing rules in
Bothland can both apply.
Explanation as to how the domestic rules might apply – the independent entity approach and
using Comparable Uncontrolled Pricing or one of the other methods.
The DTA “Associated Enterprises” (Article 9) provision is unlikely to apply in this case as it
specifically requires two separate enterprises (companies) and arguably has no relevance to a
company/branch situation.
The “Business Profits” (Article 7) is likely to apply as it deals specifically with a Company/PE
situation. This results in a ring fencing of the PE and treatment as an independent entity. The
issue is different as the question is what “business profit might the PE be expected to make if
it were a distinct and independent enterprise engaged in the same or similar activities under
the same or similar conditions and dealing wholly independently with the enterprise of which it
is a PE”.
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If domestic law and the DTA result in different outcomes, the DTA will usually override domestic
law. However, it will depend on what the domestic law provision of Bothland says as to what
prevails if there is a conflict.
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Part C
Question 5
Part 1
An APA is a negotiated agreement between members of a multinational group operating in

different countries and one or more of the revenue authorities in different countries. It is
designed to provide a forward-looking agreement on the way in which transfer prices will be
tested between the members of the multinational group for an agreed period of time and based
on agreed assumptions. APA’s can be unilateral, bilateral or multilateral in nature.
Key benefits include:
 Certainty in relation to future years of lodgement.

 Risk mitigation - Reduced chance of future compliance activity by tax administrations.
 Reduce likelihood of double taxation and Mutual Agreement Procedures
(predominantly Bilateral and Unilateral APA’s)
 Time and cost savings in preparing transfer pricing documentation for future years.
 Potential to rollback APA outcome to earlier years.
 Fostering positive relationship with tax administration.
Part 2
There is no requirement that all the members of the multinational group be parties to the APA.
A unilateral APA is between the tax administration and one member of the multinational group.
However, it is preferable to have a bilateral or multilateral APA as leaving entities out of an APA
reduces the effectiveness of the APA unless they are completely uninvolved and have no
impact on the related party transactions.
Part 3
Many of the issues identified in the BEPS Actions 8-10 report are likely to lead to more transfer
pricing disputes between tax administrators and multinationals. One such issue is the reduced
suitability of one-sided transfer pricing methods such as the transactional net margin method
(TNMM). Tax authorities are likely to request more information in the APA process and carry
out more thorough analysis than pre BEPS. For example, focus on the complete value chain
and profitability in all countries in which the multinational operates.
In relation to BEPS Action 13, multinationals must provide details of the group's existing APAs,
and other tax rulings relating to the allocation of income among countries.
In relation to BEPS Action 14, the increased level of transfer pricing controversy that may arise
because of the BEPS guidance may lead to an increase in the number of MAP and APA cases
in some countries.
Tax administrations have access to more information as a consequence of the BEPS initiatives,
putting them in a better position.
Part 4
MAP is governed by the mutual agreement procedure of the applicable double tax
agreement/treaty and Article 25 of the OECD Model Tax Convention. MAP is a mechanism for
eliminating double taxation and resolving conflicts of interpretation of the convention.
The MAP article applies to situations where a taxpayer believes that the actions of one or both
contracting states has resulted in or will result in “taxation not in accordance with the provisions
of the Convention”.
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For example, Country A has concluded a Transfer Pricing audit and made adjustments to
increase tax payable in relation to purchase of goods from an associated company in country
B. In this case, there is a treaty between Country A and B.
Part 5
A unilateral APA is unlikely to reduce the likelihood of a future MAP as the agreement is
between one multinational company and one tax administration.
In relation to a multilateral or bilateral APA, there is likely to be a reduced likelihood of double

taxation and therefore MAP in connected with the covered transactions. This is because there
is certainty with respect to covered transactions with the tax administrations which are parties
to the APA.
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Question 6
Part 1
The revision of Section E on safe harbours within Chapter IV of the July 2017 OECD Transfer
Pricing Guidelines includes new guidance that:
 provides opportunities for tax administrations to offer relief from compliance burdens
and greater certainty for situations involving smaller taxpayers or less complex
transactions; and
 provides a basis for tax administrations, especially developing countries, to design a
transfer pricing compliance environment that makes best use of its resources.
In particular, the OECD recognises that previous guidance did not accurately reflect the practice
of OECD Member countries, a number of which have adopted transfer pricing safe harbour
provisions. The OECD acknowledged that “the previous guidance was found to be 'largely
silent' with regard to the possibility of a bilateral agreement establishing a safe harbour, even
though some countries have favourable experience with such bilateral agreements.”
Generally, if the taxpayer satisfies the requirements for a safe harbour, the tax administration
will not allocate resources to undertake compliance activity in relation to the issue.
For example, there may be requirements around size of taxpayer (turnover); size of related
party transaction (materiality) and type of transaction (eg safe harbour may only apply to loans,
royalties etc).
Part 2
From a tax administrations perspective, CBC is likely to:
 Provide documentation making it easier to identify potential transfer pricing risk.

 Enable access to better quality documentation in a more timely manner.
 May encourage multinationals to be more transparent with factual information
regarding business operations, profitability in countries and value chain.
 May lead to more APA’s and MAP’s with better quality information.
 Ability to carry out transfer pricing risk assessment without for the need to request
additional documentation.
Part 3
Transfer pricing documentation is documentation that demonstrates the consistency of

conditions of a transaction with the Arm’s length principle. Typically it will address a range of
issues, including description of controlled transaction(s), industry analysis, comparability
analysis, selection of transfer pricing method, etc.
Practises regarding the timing of the preparation of the documentation differ from country to
country. In order to be regarded as contemporaneous, some countries require documentation
to be finalised by the time the tax return is lodged, whereas others require documentation to be
in place by the time the compliance activity commences.
Transfer pricing documentation requirements are a matter of domestic law and can, and do
differ from country to country. Some countries do not have specific requirements, whilst others
have very detailed requirements.
Depending on the specific laws of a country, existence of transfer pricing documentation may
shift the burden of proof. If a multinational has good quality documentation this reduces the risk
of adjustment and further compliance activity.
The existence of transfer pricing documentation may also impact on penalties.
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Question 7
Contract R & D is a common economic model within multinational groups. Multinational groups
which have significant R & D expenditure usually carrying out those activities in several
countries even though there is likely to be a facility in the group's home country.
The OECD's current view on contract research and development is largely encapsulated in
paragraph 7.41 of the 2017 Transfer Pricing Guidelines with the activity being an example of
an intra group service.
The main characteristics of contract "R & D" are the following:
 The research company does not own any intellectual property created during the
course of its activities, and
 The research company is not exposed to any commercial or financial risks as the costs,
which it incurs in carrying out its activities will be unconditionally reimbursed by the
principal - regardless of whether its research leads to economic success.
 Cost plus method may be appropriate to remunerate the research company. The
research company is reimbursed for all of its costs and also receives a percentage of
those costs as a "plus". The Guidelines state that "the additional cost plus may reflect
how innovative and complex the research carried out is" (paragraph 2.55).
A CCA is a contractual agreement reached between enterprises under which those members
share the contributions/costs and risks of producing or purchasing certain assets (tangible or
intangible), services or rights and an agreed process for sharing the results that arise from the
utilisation of those assets, services or rights.
CCAs can often be used for the joint development, enhancement, maintenance, protection or
exploitation of intangibles. A key objective in revising the OECD guidance is to align the transfer
pricing of intangibles under CCA’s to be measured at value rather than at cost. This aligns that
outcomes for parties under a CCA should not differ significantly from the outcomes of transfers
or development of intangibles for parties outside a CCA.
Consistent with the arm’s length principle, each participant’s proportionate share of the overall
contributions to a CCA must be consistent with the participant’s proportionate share of the
overall expected benefits to be received under the arrangement. Further, each participant
becomes an effective owner of an interest in any intangibles or tangible assets resulting from
the activity of the CCA, or is entitled to receive services resulting from the activity of the CCA,
and may exploit such interest or entitlement without paying additional consideration to any party
for that interest or entitlement.
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Question 8
GSK Canada
In GlaxoSmithKline Inc. v. Canada, 2010 FCA 201 (CanLII), the case is returned to the Tax
Court of Canada for consideration of the License Agreement as a circumstance relevant to the
determination of the transfer pricing used by the taxpayer.
In short, the Court states that the “contractual terms” as a whole is a key factor to determine
the arm’s length price of a controlled transaction. This is factor #3 of the comparability analysis
as per the OECD Transfer Pricing Guidelines.
In 1976, a predecessor of GlaxoSmithKline ("GSK") discovered the drug ranitidine, which was
approved for sale in Canada in 1981 and marketed as Zantac. Ranitidine's primary manufacture
was conducted by related companies located in the United Kingdom and Singapore, and it was
subsequently sold to Adechsa SA, another related company located in Switzerland, for further
sale to other group companies and unrelated distributors at prices dictated by the parent
company.
In addition, the following intercompany agreements were entered into by Glaxo Canada:
 in 1972, a Consultancy Agreement with Glaxo Group Limited covering services and
intangibles provided to Glaxo Canada in exchange for a 5% royalty
 in 1983, a Supply Agreement with Adechsa for the purchase of ranitidine
 an amendment to the 1972 agreement, to cover services and intangibles relating to
Zantac
 in 1988, a Licence Agreement with Glaxo Group Limited that replaced the 1972
agreement, and which covered various services and intangibles, in exchange for a 6%
royalty on the net sales of drugs.
During its taxation years from 1990 to 1993, Glaxo deducted and remitted withholding tax with
respect to royalty payments it made to Glaxo Group Limited under the 1988 agreement, but not
with respect to payments to Adechsa under the 1983 agreement, which were considered fully
deductible as cost of goods sold.
By 1990, generic drug manufacturers such as Apotex and Novopharm were able to acquire
ranitidine on the open market at prices significantly less than Glaxo Canada was paying under
its 1983 agreement. The Minister of National Revenue subsequently reassessed Glaxo
Canada's 1990–1993 taxation years under:
 s. 69(2),which applied where a taxpayer is not dealing at arm's length with a non-
resident and pays an amount greater than the amount "that would have been
reasonable in the circumstances if the non-resident person and the taxpayer had been
dealing at arm's length". In such a case, the transfer price is deemed to be the
reasonable amount determined on an arm's length basis.
 s. 56(2), which resulted in a deemed dividend to Adechsa, and its assessment for
withholding tax under Part XIII of the ITA.
Glaxo Canada subsequently appealed the reassessments to the Tax Court of Canada.
Tax Court of Canada
On 30 May 2008, the TCC allowed the appeals, ordering the s. 69(2) and Part XIII assessments
to be returned to the Minister for reassessment with respect to a minor pricing adjustment.
Otherwise, the approach used in arriving at the assessments was considered to be correct. Rip
A.C.J. (as he then was) identified the key issues in the case as:
1. whether the Supply Agreement and the Licence Agreement should be considered
together to determine a reasonable transfer price
2. the meaning of the phrase "reasonable in the circumstances" in s. 69(2)
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3. the impact of the differences in Glaxo's good manufacturing practices and health,
safety and environmental standards on the comparability of the ranitidine purchased
by the appellant with that purchased by the generic companies
He ruled that the comparable uncontrolled price method was the preferred approach to use to
establish the arm's length transfer price, subject to adjustment for the issues in dispute. He also
ruled that the Part XIII assessments for withholding tax were essentially correct, but subject to
a minor pricing adjustment with respect to the drug's granulation.
Federal Court of Appeal
The TCC ruling was set aside by the Federal Court of Appeal on 26 July 2010. In his
ruling Nadon J.A. stated that the trial judge had erred in the following respects:
 concluding that the Licence Agreement and Supply Agreement were to be considered
independently of one another within the context of Singleton v. Canada
misunderstanding the s. 69(2) test of what is "reasonable in the circumstances"
The Singleton test applied to a different part of the Act under different circumstances, and the
consideration of what is reasonable must be governed by the standard noted in Gabco Limited
v. Minister of National Revenue, where Cattanach J. stated:
It is not a question of the Minister or this Court substituting its judgment for what is a reasonable
amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no
reasonable business man would have contracted to pay such an amount having only the
business considerations of the appellant in mind.
Transfer Pricing with a Competitive External Market
Nadon J.A. subsequently listed the following "circumstances" of what could be considered as
reasonable in the case at bar.
1. Glaxo Group owned the Zantac trademark and would own it even if the appellant was
an arm’s length licensee.
2. Zantac commanded a premium over generic ranitidine drugs.
3. Glaxo Group owned the ranitidine patent and would have owned it even if the appellant
had been in an arm’s length relationship.
4. Without the License Agreement, the appellant would not have been in a position to use
the ranitidine patent and the Zantac trademark.
Consequently, in those circumstances, the only possibility open to the appellant would have
been to enter the generic market where the cost of entry into that market would likely have been
high, considering that both Apotex and Novopharm were already well placed and positioned.
Without the License Agreement, the appellant would not have had access to the portfolio of
other patented and trademarked products to which it had access under the License Agreement.
The appeal was allowed with costs, setting aside the Tax Court’s decision, and the matter was
returned to the trial judge for rehearing and reconsideration of the matter in the light of the
FCA's reasons.
An appeal by the Crown on the reversal, and cross-appeal by GSK with respect to the case
being returned to the TCC for rehearing, were subsequently made to the Supreme Court of
Canada, which heard the case on 13 January 2012.
Arguments before the SCC
Appeal
The Crown argued that applying a "reasonable in the circumstances" test, as the FCA did, does
not fulfil the conditions of section 69(2), as a price that may be reasonable is not necessarily an
arm's-length price. According to the Crown, only those circumstances that would be relevant to
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parties bargaining at arm‟s length for a particular good should be considered in the
analysis, which it asserted was supported by the SCC's rulings in Singleton and Shell Canada
Ltd. v. Canada. In its view, other circumstances, such as Glaxo Canada‟s status as a distributor
of Zantac, were irrelevant to the consideration of the price paid for ranitidine.
In response to questions from the Justices about the meaning of "reasonable circumstances"
in s. 69(2), the Crown submitted that:
 the phrase was intended to consider only the “economically relevant circumstances”
pertaining to the specific transaction in question, in accordance with
the OECD Transfer Pricing Guidelines[27]
 s. 69(2) did not allow consideration of “the whole deal”
As to questions as to whether a hypothetical independent licensee entering into a similar

arrangement with Glaxo could be reeassessed in the same manner, the Crown responded that
such a licensee could be reassessed as not “dealing at arm‟s length” if it was tied into a set
price and had no ability to bargain.
In its submission, GSK concurred with the FCA ruling with respect to the inclusion of the License
Agreement in determining reasonable circumstances. S. 69(2) should therefore be presumed
to situate the parties at arm's length, ultimately asking, "Would they do the deal?" As to
questions posed on whether the price paid for ranitidine was a bundled price for tangible and
intangible property—thus potentially triggering liability for withholding tax—GSK contended that
the situation was analogous to luxury brands such as Rolex and Porsche. While there are
undoubtedly components of intellectual property embedded in the price of the tangible good, it
is not Canadian law or practice to segregate and separately tax the discrete elements.
As to the applicability of the OECD guidelines, GSK stated that there was no dispute between
the parties that the issue in question is solely the price of the tangible good rather than its
characterization.
Cross-appeal
In its cross-appeal, GSK submitted that it had demolished the Minister's reassessment by
demonstrating that the theory at the heart of the liability determined by the Minister was wrong,
and therefore the reassessment must be set aside. To a question posed as to whether the onus
was still on the taxpayer to prove that it did not overpay for ranitidine (as the lower courts had
not yet addressed the issue), GSK responded that, once it had demolished the Crown's basis
for reassessment, the onus shifted to the Crown to show that Glaxo had paid too much.
In reply, the Crown contended that GSK did not demolish the reassessment, and therefore it
remained valid and open for reconsideration by the TCC. To the question of whether, if the case
were to be sent back to the TCC, any other issue could be argued, the Crown stated that the
argument would remain essentially the same, as the generic comparable prices comprised the
only available information to support arm's-length prices for ranitidine.
Decision by the SCC
Appeal
While s. 69(2) does not state what is a "reasonable amount", the OECD guidelines do provide
commentary and methodology pertaining to the issue of transfer pricing. However, the test of
any set of transactions or prices ultimately must be determined according to s. 69(2).
 The trial judge erred in relying on Singleton and Shell Canada for requiring a
transaction-by-transaction approach, but s. 69(2) only requires that the price
established in a non-arm’s length transfer pricing transaction is to be redetermined as
if it were between parties dealing at arm’s length. If the circumstances require,
transactions other than the purchasing transactions must be taken into account to
Page 17 of 28
determine whether the actual price was or was not greater than the amount that would
have been reasonable had the parties been dealing at arm’s length.
 The OECD Guidelines state that a proper application of the arm’s length principle
requires that regard be had for the “economically relevant characteristics” of the arm’s
length and non-arm’s length circumstances to ensure they are “sufficiently
comparable”.
 Considering the Licence and Supply agreements together offers a realistic picture of
the profits of Glaxo Canada. It cannot be irrelevant that Glaxo Canada’s function was
primarily as a secondary manufacturer and marketer. It did not originate new products
and the intellectual property rights associated with them. Nor did it undertake the
investment and risk involved with originating new products. Nor did it have the other
risks and investment costs which Glaxo Group undertook under the Licence
Agreement. The prices paid by Glaxo Canada to Adechsa were a payment for a bundle
of at least some rights and benefits under the Licence Agreement and product under
the Supply Agreement.
It was also noted that the issue as to whether the purchase price includes compensation for
intellectual property rights granted to Glaxo Canada had not been specifically argued before
the SCC, and could still trigger potential further liability for Part XIII withholding tax. It may still
be raised during the subsequent rehearing at the TCC.
The following further guidance was given with respect to the forthcoming redetermination by
the trial judge:
1. In determining what constitutes a "reasonable amount" under s. 69(2), even the OECD
guidelines concede that “transfer pricing is not an exact science”. As long as a transfer
price is within what the court determines is a reasonable range, the requirements of the
section should be satisfied.
2. While assessment of the evidence is a matter for the trial judge, the respective roles
and functions of Glaxo Canada and the Glaxo Group should be kept in mind. Whether
or not compensation for intellectual property rights is justified in this particular case, is
a matter for determination by the Tax Court judge.
3. Prices between parties dealing at arm’s length will be established having regard to the
independent interests of each party to the transaction, and an appropriate
determination under the arm’s length test of s. 69(2) should reflect these realities.
4. In this case there is some evidence that indicates that arm’s length distributors have
found it in their interest to acquire ranitidine from a Glaxo Group supplier, rather than
from generic sources. This suggests that higher-than-generic transfer prices are
justified and are not necessarily greater than a reasonable amount under s. 69(2).
Cross-appeal
The assessments were based on two assumptions:
 the Appellant paid Adechsa, with whom it was not dealing at arm’s length, a price for
ranitidine which was greater than the amount that would have been reasonable in the
circumstances if the Appellant and Adechsa had been dealing at arm’s length
 any amounts paid by the appellant to Adechsa over and above the prices paid by other
Canadian pharmaceutical companies were not for the supply of ranitidine
Only the second could be characterized as having been demolished, but if Glaxo had been
successful in establishing that the prices it paid were reasonable, the first would have been
demolished as well. As L’Heureux-Dubé J. had stated in Hickman Motors Ltd. v. Canada, the
taxpayer’s burden is to “‘demolish’ the exact assumptions made by the Minister but no more” .
As Glaxo had previously conceded at the FCA that the court could determine what was the
reasonable amount, it was within the FCA's discretion to remit the question to the TCC for that
very determination. Accordingly, that aspect of the FCA's ruling was upheld.
Impact
Page 18 of 28
There has been little jurisprudence on transfer pricing in Canada, and, being the first time this
area had been addressed by the SCC, the judgment was greatly anticipated, not just in
Canada but worldwide. While many tax professionals welcomed the SCC endorsement of a
"business reality test", others had been expecting more specific guidance. There was also
speculation that the time may be ripe for the Crown and GSK to reach a settlement, rather than
spend more time in pursuing a rehearing at the TCC. The case was ultimately settled on 12
January 2015, prior to the TCC's rehearing of the matter, with details of the agreement
remaining confidential.
The SCC's statement that an arm's-length price can fall within an acceptable range of prices
has also been seen as significant, and consistent with the 2010 OECD transfer pricing
guidelines, as it appears to be contrary to the long-standing policy of the Canada Revenue
Agency to express a preference for unweighted yearly averages of comparators’ pricing in such
circumstances. In addition, the SCC's guidance to the TCC strongly suggests that Canadian
courts must keep an eye on the bigger picture in making their transfer pricing determinations,
and the determination of arm’s-length pricing is quite distinct from the narrower concept of fair
market value.
When s. 69(2) was reenacted as s. 247(2)(a) and (c) in 1998, the test as to what was reasonable
"in the circumstances" was removed. However, it has been contended that the quoted words
are implicit in the comparative exercise mandated by the explicit adoption of the arm’s-length
principle in subsection 247(2) and the Tax Court of Canada has held that GlaxoSmithKline's
reasoning continues to apply to s. 247 cases. It should be noted that s. 247 also contains a
recharacterization rule at s. 247(2)(b) and (d) that has yet to be assessed in the Canadian
courts.
Most recently, it has been argued that the SCC erred in affirming the FCA's application of a
reasonable business person test for the purpose of s.69(2), and that the SCC infused additional
uncertainty as to which arm’s length test applies (i.e., an empirical arm’s length test or a
reasonable business person test). These errors may require having the court overrule its
decision in order to properly consider the Minister’s question about the appropriateness of the
reasonable business person test.
Page 19 of 28
Netherlands/Starbucks state aid [SA.38374]
In the decision dated 21 October 2015 (the decision), the European Commission determined
that the advance pricing agreement (APA) entered into between the Dutch Tax Authorities and
Starbucks Manufacturing EMEA B.V. (SMBV) on 28 April 2008, relating to the period 1 October
2007 to 31 October 2017, includes prohibited State aid (State aid number SA.38374). An APA
is an agreement between tax authorities and a taxpayer concerning the application of the tax
legislation in relation to (future) transactions. Set out in such an agreement are the criteria
suitable for determining the corporate transfer prices for intragroup transactions during a
specific period. Calculations are made based on that to determine how much profit from a
taxpayer’s activities will be taken into consideration in that fiscal jurisdiction and how much
corporation tax is payable annually thereby. An APA is initiated through an application from a
taxpayer.
Assessment by the European Commission of the APA with SMBV 2.1: Conditions for the
existence of State aid According to Article 107, paragraph 1, of the Treaty on the Functioning
of the European Union (TFEU), Sstate aid measures are (i) from a Member State or funded by
state means in whatever manner, which (ii) could have an unfavourable influence on the trade
between Member States (iii) by giving advantages to certain companies or certain productions
and (iv) thus distort the competition, or threaten to do so, which is incompatible with the internal
market. The first condition is fulfilled. The APA was entered into by the Tax Authorities, which
are part of the Dutch government. The APA can therefore be attributed to the Netherlands. In
addition, the APA leads to a loss of tax income, which the Netherlands would otherwise have
at its disposal. This means that the APA is considered to lead to a loss of state means.
The second condition is also fulfilled. SMBV is part of the Starbucks Group, which is active
worldwide and in all the Member States of the European Union, which means that aid could
affect trade within the Union. Furthermore, the third condition is fulfilled. The APA allows
Starbucks a selective advantage, insofar as that measure leads to a reduction in the tax payable
by SMBV in the Netherlands. The greater part of the decision is dedicated to this condition in
the Commission’s assessment. Finally, the fourth condition is also fulfilled. Since the APA
discharges SMBV from payable taxes, which it would otherwise have been required to pay, this
measure strengthens the financial position of Starbucks in respect of other competing
companies, whereby the competition is distorted or threatens to be distorted.
Since all the conditions are fulfilled, the APA amounts to State aid within the meaning of Article
107, paragraph 1, of the TFEU.
Fiscal State aid test In order to determine whether a specific tax measure contains a selective
advantage, a fiscal State aid test has been developed in the European case law, comprising
three steps. The first step entails determining which general or normal tax regulations are
applicable in the Member State: “the reference system”. The second step entails determining
whether the tax measure involved forms a deviation from that reference system. If the measure
does form a deviation from the reference system, then it is determined during the third step of
the analysis whether that measure is justified by the nature and general scheme of the
reference system.
The reference system is formed by the general Dutch system of corporation tax, which is
targeted at the tax on profits of all taxpaying companies in the Netherlands, irrespective of
whether that concerns a group of companies or an independent company. That the taxable
profits for integrated and nonintegrated companies are calculated in a different manner out of
necessity is not important for determining the reference system.
Contrary to the argument put forward by the Netherlands, the reference system is not formed
through Section 8b of the Corporation Tax Act and the Transfer Pricing Decree, which contain
specific rules for group companies. By assuming, in the manner used by the Netherlands, that
the reference system only concerns group companies, then an artificial distinction is made
between companies on the basis of their company structure. That is all the more true, since the
Transfer Pricing Decree is intended to ensure that group companies and independent
companies are handled in a similar manner on grounds of the Dutch system of corporation tax.
Page 20 of 28
If the Transfer Pricing Decree is however intended to establish special rules for integrated
companies, which deviate from the general Dutch rules concerning corporation tax, then its
implementation is selective in itself, which means that all advantages given on grounds of those
regulations are selective.
Arm’s length principle: Since it has now been established that the general Dutch system of
corporation tax is the reference system against which the APA should be tested, then it must
be ascertained whether that APA forms a deviation from that system, whereby companies that
are in a comparable situation, actually and legally, are handled unequally. This is on the basis
of the arm’s-length principle. The system applied by the Commission in the state aid
assessment does not follow from the non-binding OECD Model Tax Convention relating to
taxes, but concerns a general principle under European law of equal fiscal treatment.
The methodological choices in the transfer pricing report provided by the tax adviser for
Starbucks, which were accepted by the Tax Authorities in the APA, do not lead to a reliable
approach to a market result and thereby do not fulfil the arm’s length principle. More specifically,
this concerns: - the choice to apply the transactional net margin method (TNMM) in order to
forecast a taxable profit, while the OECD guidelines and the Transfer Pricing Decree show a
preference for the Comparable Uncontrolled Price Method (CUP); - if the CUP was applied,
then the taxable profit of SMBV would be substantially higher, because: - i) the royalties paid
by SMBV to Alki LP for knowhow in the area of coffee roasting are too high; - ii) the purchase
price paid by SMBV for green beans to a company established in Switzerland and belonging to
the Starbucks Group, Starbucks Coffee Trading Company SARL (SCTC), is too high.
Alternatively, the Commission is of the opinion that the TNMM is applied incorrectly: - i) it was
incorrectly assumed that SMBV (in comparison with a company established in the United
Kingdom and belonging to the Starbucks Group: Alki LP) should be designated as “least
complex function” and therefore applies for the application of the TNMM as the “tested party”;
and ii) in connection with the comparability of SMBV with other market participants in the coffee
trade sector, two corrections in the cost base were wrongly carried out. These choices resulted
in SMBV’s taxable basis being too limited, whereby SMBV enjoys a tax advantage in the
Netherlands.
The payment of royalties by SMBV to Alki LP does not provide a correct representation of the
value of the intellectual property rights and therefore cannot be deemed to be arm’s length. The
royalties comprise an adjustment variable, the level of which is determined by the accounting
profits of SMBV combined with the compensation agreed in the APA in the form of a fixed mark-
up on the operational costs of SMBV. This means that the APA contains no method of being
able to assess the arm’s length nature of the level of the royalties. In addition, on the basis of
a CUP test, the actual price that SMBV would have been willing to pay for the royalties – in an
arm’ s length transaction – would have amounted to nil. This can be deduced from a few
comparable agreements for roasting coffee, which Starbucks had entered into with other coffee
roasters worldwide. Alki LP should not have been paid any royalties. Those royalties, which
were paid for years, therefore cannot be arm’s length, even more so because SMBV does not
appear to gain any business advantage itself from the use of the intellectual property in the
area of roasting coffee. An independent company would not have been prepared to pay for
licences if it was unable to earn back the royalties paid. In addition, the payment for royalties
does not represent a payment for taking over the company risks. The argument from the Tax
Authorities that Alki LP (and not SMBV) carried the economic risk of loss of stock is not
accepted by the Commission. By accepting this reasoning, the application of the arm’s-length
principle for the pricing policy for intragroup transactions would be pointless since the economic
reality could in fact be reasoned away or contracted out of as an alternative. Moreover, Alki
LP’s capacity is too limited for actually being able to carry such risks. This can be illustrated by
the fact that the latter company has no employees itself. The level of the royalty payments also
cannot be justified by the amounts Alki LP pays to Starbucks US for technology.
Purchase of green beans The purchase price of green beans paid by SMBV to SCTC is
abnormally high and therefore does not comply with the arm’s-length principle. In the first place,
there was a failure to investigate the extent to which the transactions between SCTC and SMBV
– the purchase and delivery of green coffee beans – actually take place arm’s length. Starbucks
has also not provided any grounds for justification of the significant increase as from 2011 of
Page 21 of 28
the mark-up in the costs for the coffee beans supplied by SCTC. The Tax Authorities should
also not have accepted this deduction from the accounting profits. That SCTC’s activities
became increasingly important, partly due to the evolving “C.A.F.E. Practices” programme,
does not form grounds for justification. Taking similar fair-trade programmes into account (and
the costs of those), the figures provided by Starbucks in connection with that are problematic
both in terms of consistency as well as the arm’s length nature. Moreover, the losses incurred
through SMBV’s coffee roasting activities since 2010 can be connected directly to the increased
mark-up. This also highlights the non arm’s length of this mark-up. SMBV’s profits are reduced
artificially by purchasing green coffee beans at a non- arm’s length price, due to its high level.
Least complex function SMBV was wrongly designated as the “least complex function” for the
application of the TNMM. Determining the least complex function takes place prior to the
application of the TNMM as transfer price method. In order to determine the entity with the least
complex function, a function comparison must be made. The outcome of the function
comparison indicates an entity, to which the transfer price method can be applied in the most
reliable manner and for which the most reliable comparison points can be found. In its coffee
roasting function, SMBV does not only carry out routine activities. SMBV conducts market
research (outgoings were paid for market research) and it holds significant intellectual property
(there is amortisation of intangible assets). Moreover, SMBV performs an important resale
function. A routine producer is not involved in such activities. Alki LP’s activities are very limited
in comparison with that. Besides the fact that Alki LP has no employees as well as a limited
operational capacity, the financial capacity of Alki LP cannot be equated with the total financial
capacity of the worldwide Starbucks Group.
Alternative standpoint of the Commission: Even if Section 8 of the Corporation Tax Act and the
Transfer Pricing Decree are used as the reference system, a selective advantage is given by
means of the APA agreed with SMBV. Also in that case the APA cannot be deemed to provide
a reliable approach to a market result in accordance with the arm’s-length principle and the
payable tax is reduced in comparison with other group companies that are required to pay tax
in the Netherlands.
The APA amounts to State aid within the meaning of Article 107, paragraph 1, of the TFEU and
is incompatible with the internal market. Since the Netherlands has not notified to the
Commission any intention to grant the contested aid measure, there is a case of illegal aid
being provided to SMBV and the Starbucks Group, which is carried out contrary to Article 108,
paragraph 3, of the TFEU. This illegal aid, including interest from the date on which it became
available until the date of repayment in full, must be claimed back immediately and effectively
from SMBV (or otherwise from the Starbucks Group). The decision must be implemented by
the Netherlands within four months of the date of notification.
Page 22 of 28
Ireland/Apple state aid [SA.38373]
The European Commission concluded that Ireland granted undue tax benefits of up to €13
billion to Apple. This is illegal under EU state aid rules, because it allowed Apple to pay
substantially less tax than other businesses. Ireland must now recover the illegal aid.
Commissioner Margrethe Vestager, in charge of competition policy, said: "Member States

cannot give tax benefits to selected companies – this is illegal under EU state aid rules. The
Commission's investigation concluded that Ireland granted illegal tax benefits to Apple, which
enabled it to pay substantially less tax than other businesses over many years. In fact, this
selective treatment allowed Apple to pay an effective corporate tax rate of 1 per cent on its
European profits in 2003 down to 0.005 per cent in 2014."
Following an in-depth state aid investigation launched in June 2014, the European Commission
has concluded that two tax rulings issued by Ireland to Apple have substantially and artificially
lowered the tax paid by Apple in Ireland since 1991. The rulings endorsed a way to establish
the taxable profits for two Irish incorporated companies of the Apple group (Apple Sales
International and Apple Operations Europe), which did not correspond to economic reality:
almost all sales profits recorded by the two companies were internally attributed to a "head
office". The Commission's assessment showed that these "head offices" existed only on paper
and could not have generated such profits. These profits allocated to the "head offices" were
not subject to tax in any country under specific provisions of the Irish tax law, which are no
longer in force. As a result of the allocation method endorsed in the tax rulings, Apple only paid
an effective corporate tax rate that declined from 1% in 2003 to 0.005% in 2014 on the profits
of Apple Sales International.
This selective tax treatment of Apple in Ireland is illegal under EU state aid rules, because it
gives Apple a significant advantage over other businesses that are subject to the same national
taxation rules. The Commission can order recovery of illegal state aid for a ten-year period
preceding the Commission's first request for information in 2013. Ireland must now recover the
unpaid taxes in Ireland from Apple for the years 2003 to 2014 of up to €13 billion, plus interest.
The tax treatment in Ireland enabled Apple to avoid taxation on almost all profits generated by
sales of Apple products in the entire EU Single Market. This is due to Apple's decision to record
all sales in Ireland rather than in the countries where the products were sold. This structure is
however outside the remit of EU state aid control. If other countries were to require Apple to
pay more tax on profits of the two companies over the same period under their national taxation
rules, this would reduce the amount to be recovered by Ireland.
Apple's tax structure in Europe
Apple Sales International and Apple Operations Europe are two Irish incorporated companies
that are fully-owned by the Apple group, ultimately controlled by the US parent, Apple Inc. They
hold the rights to use Apple's intellectual property to sell and manufacture Apple products
outside North and South America under a so-called 'cost-sharing agreement' with Apple Inc.
Under this agreement, Apple Sales International and Apple Operations Europe make yearly
payments to Apple in the US to fund research and development efforts conducted on behalf of
the Irish companies in the US. These payments amounted to about US$ 2 billion in 2011 and
significantly increased in 2014. These expenses, mainly borne by Apple Sales International,
contributed to fund more than half of all research efforts by the Apple group in the US to develop
its intellectual property worldwide. These expenses are deducted from the profits recorded by
Apple Sales International and Apple Operations Europe in Ireland each year, in line with
applicable rules.
The taxable profits of Apple Sales International and Apple Operations Europe in Ireland are
determined by a tax ruling granted by Ireland in 1991, which in 2007 was replaced by a similar
second tax ruling. This tax ruling was terminated when Apple Sales International and Apple
Operations Europe changed their structures in 2015.
Apple Sales International
Page 23 of 28
Apple Sales International is responsible for buying Apple products from equipment
manufacturers around the world and selling these products in Europe (as well as in the Middle
East, Africa and India). Apple set up their sales operations in Europe in such a way that
customers were contractually buying products from Apple Sales International in Ireland rather
than from the shops that physically sold the products to customers. In this way Apple recorded
all sales, and the profits stemming from these sales, directly in Ireland.
The two tax rulings issued by Ireland concerned the internal allocation of these profits within
Apple Sales International (rather than the wider set-up of Apple's sales operations in Europe).
Specifically, they endorsed a split of the profits for tax purposes in Ireland: Under the agreed
method, most profits were internally allocated away from Ireland to a "head office" within Apple
Sales International. This "head office" was not based in any country and did not have any
employees or own premises. Its activities consisted solely of occasional board meetings. Only
a fraction of the profits of Apple Sales International were allocated to its Irish branch and subject
to tax in Ireland. The remaining vast majority of profits were allocated to the "head office", where
they remained untaxed.
Therefore, only a small percentage of Apple Sales International's profits were taxed in Ireland,
and the rest was taxed nowhere. In 2011, for example (according to figures released at US
Senate public hearings), Apple Sales International recorded profits of US$ 22 billion (c.a. €16
billion[1]) but under the terms of the tax ruling only around €50 million were considered taxable
in Ireland, leaving €15.95 billion of profits untaxed. As a result, Apple Sales International paid
less than €10 million of corporate tax in Ireland in 2011 – an effective tax rate of about 0.05%
on its overall annual profits. In subsequent years, Apple Sales International's recorded profits
continued to increase but the profits considered taxable in Ireland under the terms of the tax
ruling did not. Thus this effective tax rate decreased further to only 0.005% in 2014.
Apple Operations Europe
On the basis of the same two tax rulings from 1991 and 2007, Apple Operations
Europe benefitted from a similar tax arrangement over the same period of time. The company
was responsible for manufacturing certain lines of computers for the Apple group. The majority
of the profits of this company were also allocated internally to its "head office" and not taxed
anywhere.
Commission assessment
Tax rulings as such are perfectly legal. They are comfort letters issued by tax authorities to give
a company clarity on how its corporate tax will be calculated or on the use of special tax
provisions.
The role of EU state aid control is to ensure Member States do not give selected companies a
better tax treatment than others, via tax rulings or otherwise. More specifically, profits must be
allocated between companies in a corporate group, and between different parts of the same
company, in a way that reflects economic reality. This means that the allocation should be in
line with arrangements that take place under commercial conditions between independent
businesses (so-called "arm's length principle").
In particular, the Commission's state aid investigation concerned two consecutive tax rulings
issued by Ireland, which endorsed a method to internally allocate profits within Apple Sales
International and Apple Operations Europe, two Irish incorporated companies. It assessed
whether this endorsed method to calculate the taxable profits of each company in Ireland gave
Apple an undue advantage that is illegal under EU state aid rules.
The Commission's investigation has shown that the tax rulings issued by Ireland endorsed an
artificial internal allocation of profits within Apple Sales International and Apple Operations
Europe, which has no factual or economic justification. As a result of the tax rulings, most sales
profits of Apple Sales International were allocated to its "head office" when this "head office"
had no operating capacity to handle and manage the distribution business, or any other
substantive business for that matter. Only the Irish branch of Apple Sales International had the
Page 24 of 28
capacity to generate any income from trading, i.e. from the distribution of Apple products.
Therefore, the sales profits of Apple Sales International should have been recorded with the
Irish branch and taxed there.
The "head office" did not have any employees or own premises. The only activities that can be
associated with the "head offices" are limited decisions taken by its directors (many of which
were at the same time working full-time as executives for Apple Inc.) on the distribution of
dividends, administrative arrangements and cash management. These activities generated
profits in terms of interest that, based on the Commission's assessment, are the only profits
which can be attributed to the "head offices".
Similarly, only the Irish branch of Apple Operations Europe had the capacity to generate any
income from trading, i.e. from the production of certain lines of computers for the Apple group.
Therefore, sales profits of Apple Operation Europe should have been recorded with the Irish
branch and taxed there.
On this basis, the Commission concluded that the tax rulings issued by Ireland endorsed an
artificial allocation of Apple Sales International and Apple Operations Europe's sales profits to
their "head offices", where they were not taxed. As a result, the tax rulings enabled Apple to
pay substantially less tax than other companies, which is illegal under EU state aid rules.
This decision does not call into question Ireland's general tax system or its corporate tax rate.
Furthermore, Apple's tax structure in Europe as such, and whether profits could have been
recorded in the countries where the sales effectively took place, are not issues covered by EU
state aid rules. If profits were recorded in other countries this could, however, affect the amount
of recovery by Ireland (see more details below).
Recovery
As a matter of principle, EU state aid rules require that incompatible state aid is recovered in
order to remove the distortion of competition created by the aid. There are no fines under EU
State aid rules and recovery does not penalise the company in question. It simply restores
equal treatment with other companies.
The Commission has set out in its decision the methodology to calculate the value of the undue
competitive advantage enjoyed by Apple. In particular, Ireland must allocate to each branch all
profits from sales previously indirectly allocated to the "head office" of Apple Sales International
and Apple Operations Europe, respectively, and apply the normal corporation tax in Ireland on
these re-allocated profits. The decision does not ask for the reallocation of any interest income
of the two companies that can be associated with the activities of the "head office".
The Commission can only order recovery of illegal state aid for a ten-year period preceding the
Commission's first request for information in this matter, which dates back to 2013. Ireland must
therefore recover from Apple the unpaid tax for the period since 2003, which amounts to up to
€13 billion, plus interest. Around €50 million in unpaid taxes relate to the undue allocation of
profits to the "head office" of Apple Operations Europe. The remainder results from the undue
allocation of profits to the "head office" of Apple Sales International. The recovery period stops
in 2014, as Apple changed its structure in Ireland as of 2015 and the ruling of 2007 no longer
applies.
The amount of unpaid taxes to be recovered by the Irish authorities would be reduced if other
countries were to require Apple to pay more taxes on the profits recorded by Apple Sales
International and Apple Operations Europe for this period. This could be the case if they
consider, in view of the information revealed through the Commission’s investigation, that
Apple's commercial risks, sales and other activities should have been recorded in their
jurisdictions. This is because the taxable profits of Apple Sales International in Ireland would
be reduced if profits were recorded and taxed in other countries instead of being recorded in
Ireland.
Page 25 of 28
The amount of unpaid taxes to be recovered by the Irish authorities would also be reduced if
the US authorities were to require Apple to pay larger amounts of money to their US parent
company for this period to finance research and development efforts. These are conducted by
Apple in the US on behalf of Apple Sales International and Apple Operations Europe, for which
the two companies already make annual payments.
Finally, all Commission decisions are subject to scrutiny by EU courts. If a Member State
decides to appeal a Commission decision, it must still recover the illegal state aid but could, for
example, place the recovered amount in an escrow account pending the outcome of the EU
court procedures.
Page 26 of 28
Question 9
Part 1
Transfer Pricing issues for the Sargent group could include the following:
 The arm’s length nature of the interest rates on the intra-group financial arrangements
(pricing).
 The terms and conditions in relation to the various intra-group financial arrangements.
 The purpose / commercial rationale for the intra-group financial arrangements.
 Credit ratings and margins of group members/subsidiaries and parent.
 Third party debt and potential CUPs.
 Implicit / explicit support and guarantees.
 Foreign exchange risks / alternative currencies.
 Arm’s length nature of the cash pooling arrangement.
 Nature of the financial instruments used and terms/conditions of the agreements
entered into.
 Alternative options / arrangements considered.
 Debt/equity classification of the financial instruments.
 Thin capitalisation interaction with transfer pricing and safe harbour consideration.
It would be important for you to understand the global funding arrangements and flow of funds
between all entities within the group. The form of the arrangements (legal agreements) would
need to be gathered and terms/conditions understood. All related party and third party financing
arrangements would need to be analysed. Any refinancing of financial instruments would also
need to be considered.
Anti-avoidance provisions would need to be considered in addition to transfer pricing.
Part 2
Further to the transfer pricing considerations above, the two OECD Base Erosion and Profit
Shifting Project Action Items that would require examination in relation to the Sargent group
are:
 Action Item 2: Neutralising The Effects of Hybrid Mismatch Arrangements:

- Action 2 of BEPS deals with hybrid mismatch arrangements. These are
arrangements that achieve a double non-taxation outcome by exploiting
differences in the way that jurisdictions treat certain entities or instruments for
tax purposes.
- The Action 2 report divides hybrid mismatch arrangements into three broad
categories, based on the tax outcome generated rather than the nature of the
hybrid arrangement itself. These categories are: deduction/no inclusion (D/NI)
outcome; double deduction (DD) outcome; and imported mismatch or indirect
D/NI outcome.
 Action Item 4: Linking Base Erosion Involving Interest Deductions and other Financial
Payments:
- Financial instruments can also be used to make payments which are
economically equivalent to interest but have a different legal form, therefore
escaping restrictions on the deductibility of interest. Base Erosion and Profit
Shifting (BEPS) risks in this area may arise in three basic scenarios:
1) Groups placing higher levels of third party debt in high tax countries.
2) Groups using intragroup loans to generate interest deductions in
excess of the group’s actual third party interest expense.
3) Groups using third party or intragroup financing to fund the generation
of tax exempt income.
The Action 4 report analyses several best practices and recommends an approach which
directly addresses the risks outlined above. The recommended approach is based on a fixed
Page 27 of 28
ratio rule which limits an entity’s net deductions for interest and payments economically
equivalent to interest to a percentage of its earnings before interest, taxes, depreciation and
amortisation (EBITDA).
Page 28 of 28
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ADIT Transfer Pricing Module Brochure

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TRANSFER PRICING

What you’ll cover

What you’ll gain

I Fundamental sources 15%

II The Arm’s Length Principle (ALP)

A Interpretation of the arm’s length principle and current dialogue 3

III Functional analysis

A Goal of functional analysis 1

IV Transfer pricing methods

A Significance of comparability and factors determining comparability 3

VII Permanent Establishments (PEs)

A Article 5 Permanent Establishments (OECD and UN Models) 1

VIII Compliance issues

IX Avoiding Double Taxation and dispute resolution

A Base Erosion and Profit Shifting project 3

Course Provision OECD, Committee on Fiscal Affairs. Transfer Pricing

Tolley Exam Training. ADIT International Materials for

Additional Reading Case Law

OECD BEPS page:

OECD Transfer Pricing page:

Pacific Association of Tax Administrators (PATA) Transfer

United Nations: www.un.org/esa/ffd

Transparent and accessible past papers Other papers available

MODULE 3.03 – TRANSFER PRICING OPTION

TIME ALLOWED – 3¼ HOURS

You need to answer five questions in total.

You must answer:

You are required to answer BOTH questions from this Part.

The following facts apply to both Questions 1 and 2

You are required to:

2. You are required to:

1) Discuss each of the OECD recommended transfer pricing methods in

2) Explain the significance of a comparability analysis, and discuss how this

You are required to answer ONE question from this Part.

3. The Bonnie Group (Bonnie) is a multinational group of companies which is a market

Bonnie recently engaged a global adviser to implement a supply chain transformation

 A new subsidiary (Sub Z) was established in Country Z and instructed to undertake

 Bonnie Corp provided funds, on an interest-free basis, to Sub Z in order to finance

 A small number of key operational staff in the areas of manufacturing, research

You are required to:

You are required to:

1) Explain, in your own words, the concept of a ‘branch’ or ‘permanent

2) Which of the above options would you recommend to Albo’s management

You are required to answer TWO questions from this Part.

1) What is an Advanced Pricing Arrangement (APA)? Outline the benefits of an

4) In what circumstances can the Pineapple Group request Mutual Agreement

1) Explain the concept of a transfer pricing ‘safe harbour’, with specific

2) Explain why Country by Country documentation is important, from a tax

3) Advise why is it important for a multinational group to prepare good quality

a) Contract research and development; and (4)

b) A cost contribution arrangement or cost sharing arrangement. (4)

 GSK Canada [2010 FCA 201]

You are required to choose one of these cases, and explain:

1) The applicable facts of the case;

2) The issue which was contested;

3) The decision made by highest court deciding the case; and

You are required to:

1) Discuss the potential transfer pricing issues in relation to the intra-group

2) Discuss potential intra-group financing transfer pricing risks for Sargent

MODULE 3.03 – TRANSFER PRICING OPTION

GDC Functions Assets Risks Characterisation

ParentCo Management Intellection Property Market Entrepreneur,

DC1 Contract Plant and equipment Market Contract

DC3 Distribution of raw Human capital Market Low risk