Funds: Transfer Pricing 9 February 2006 J IN -Y OUNG L EE

Agenda Introduction/objectives Overview of recent developments Case study

3 OECD Development on Financial Sector Issues 1984: Transfer Pricing and Multinational Enterprises: Three Taxation Issues – The Taxation of multinational Banking Enterprises 1994: Model Tax Convention: Attribution of Income to Permanent Establishments 1995: Transfer Pricing Guidelines – Art : Global Trading Report

4 The OECD Report on the Attribution of Profits to Permanent Establishments The project in overview – Part I (General Introduction): Part II (Traditional Banking Activities): Part III (Global Trading); Part IV (Insurance) Discussion Drafts - February 2001; March 2003 and 2004 Consultation process – Paris in April 2002; Zurich 2003 and Paris in October 2004

5 Objective Highlight recent developments on the application of transfer pricing to funds

6 Trends - historic 1950s → 1970s 1970s → 1980s 1990s → 2005 Self police Distortive behaviours sensitise the TP issue – big ticket fights The arm’s length principle confirmed supreme Short cuts: Cost plus ‘Emperors’ clothes’ comparables Silver linings: Contract terms Planning ‘structures’

7 Typical structure Offshore Manager Offshore Manager Onshore Manager Onshore Manager Investments Management Services Agreement Investment Management Services Funds 100%

8 Trends Rejection of ‘self policing’ Recognition that businesses operate globally Rejection of ‘short cuts’ Less cost plus, more profit split? People are less mobile than capital Key Entrepreneur Risk Takers ‘Fairness’ and ‘stability’ implicitly preferred over the arm’s length principle

9 Key principles KERTS identification analysis WILL drive transfer pricing models

10 Funds – Key points Level of assets under management Type of assets and investment strategies What functions create value Integration between the functions performed in each location Organisation chart Headcount in each company Granularity of available data Type and location of customers Arrangements with 3 rd parties

11 Cost plus Issues with cost or cost plus approaches Is cost plus still valid? Interaction with other transfer pricing policies – embedded or allocated? On-going review required

12 Revenue sharing Use of automatic revenue sharing arrangements? Do the functions in each location merit a share of revenues? Attributor of marketing fees Trading profit allocation methodolgy

13 Profit split Residual or total? Identification of allocation keys Interaction with regulatory requirements Availability of data VAT considerations

14 Definition of profit pots Companies & partnerships & integrated business KERTS not cost plus Conflict between personal & corporate tax

15 Case study

16 Summary Arm’s length principle important as business becomes global Identification of key value drivers KERTs – increasing importance Appropriateness of cost plus Permanent establishment risks

Case study Optimal Fund Management (‘OFM’) is a hedge fund manager based in the Cayman Islands and is the manager of the Optimised Fund (‘the Fund’), a hedge fund also based in the Cayman Islands. It has experienced rapid growth over the past 2 years and now has operations in the UK, US, Switzerland and Germany. Due to forecast growth in Asia, it intends establishing a presence in Hong Kong and Singapore in the next 3-6 months (initially marketing & distribution & possibly investment management/research longer term). The Fund pays all management (2%) and performance fees (20%) to OFM. OFM has delegated the investment management activities to its subsidiary companies - Optimal UK (‘OUK’) and Optimal US (‘OUS’). During the past year, OUK has established a branch in Japan to undertake investment research. When the Fund was initially launched, OFM was responsible for the marketing of the Fund. However, recently it has delegated this function to Optimal Switzerland (‘OPS’) which is now responsible for the global marketing and distribution strategy for the Fund. OPS is also responsible for the marketing and distribution of the fund in continental Europe. OUK, OUS and Optimal Germany are also responsible for marketing & distribution of the fund in UK, North America and Germany/Austria, respectively. OPS also uses third parties to distribute the Fund, for which they receive a fee equal to 15-30% of the management fees (and in some cases performances fees) in respect of AUM introduced. OUK is also responsible for providing all the back-office support services to the Group. The Group is owned by 7 key principals. OUK has 15 employees in its investment management section (including 3 principals). There are 3 employees dedicated to marketing/distribution (including 1 principal). There are 15 employees providing back-office support. OUS has 10 employees in its investment management section (including 2 principals). There are 2 employees dedicated to marketing/distribution. OPS has 3 employees undertaking its global marketing responsibility (including 1 principal), while Germany has 2 employees. There are 3 employees in Japan undertaking investment research. The investment management team in the US and UK hold daily conference calls to discuss the investment strategy and trading for the Fund. On a weekly basis, OPS holds a conference call to discuss the global sales strategy and sales performance with the marketing/distribution teams. One of the principals of OUK lives in the US. The principal is responsible for determining the investment trading strategy for the Fund. The principal commutes to London on a monthly basis for up to 5 days per month and participates on the daily investment management conference calls while in the US. The principal also spends time in the US office providing support to the OUS (ie attending new client meetings to explain strategy). Due to expansion of its operations globally, Optimal is concerned about its transfer pricing. Optimal has approached you for advice on the appropriate transfer pricing policy for its global operations. In particular, it has asked you to consider: 1. The appropriateness and issues associated with adopting the following transfer pricing methodology: a.Cost plus b.Revenue sharing c.Profit split 2. Other tax issues? (Hint: taxable presence in other jurisdiction?) 3. The approach of tax authorities in Korea to transfer pricing?

Case study Optimal Fund Management (Cayman) Optimal UK (IM/Mkting/Dist) Optimal Germany (Mkting/Dist) Owners 100% Master Fund (Cayman Island) Management contract Optimal Switzerland (Marketing) Optimal US (IM/Mkting/Dist) 100% OUK Sub (UK Ltd) OUK Korea (Korean Branch) Investment Management contract Investment Manager & Distributor (Hong Kong & Singapore) 3 rd Party Distributo rs