0 Tax Conference in Istanbul Transfer Pricing Rules in Turkey Ceylan Intercontinental Hotel, 22 November 2006 Documentation / TP Defense etc. Dr. Gerhard Engler BDO Deutsche Warentreuhand AG Grüneburgweg Frankfurt am Main Tel / Fax / BDO Denet

1 1 Documentation  1.1 National laws  1.2 International harmonisation efforts  1.3 EU Code of conduct  1.4 Usual steps for TP documentation  1.5 Content of TP report 2 Transfer Pricing Defense 2.1 Overview 2.2 Appeals 2.3 Mutual Agreement Procedure (MAP) 2.4 EU Arbitration Procedure 2.5 Advance Pricing Agreements (APA) 3 OECD Developments  3.1 Permanent Establishments  3.2 MAP Manual  3.3 Discussion on Profit Methods 4 Conclusion Documentation / TP Defense etc. – Topics

2 1 Documentation 1.1 National laws Countries with own documentation law

3 1 Documentation 1.2 International harmonisation efforts PATA Guidelines (Pacific and North America: Canada, USA, Australia, Japan) EU Code of Conduct on TP Documentation (EU TPD) EU TPD will be best practice across Europe whether or not taxpayers opt in or not; failure to comply with EU TPD could expose taxpayers to penalties

4 Historical problems  Different EU tax authorities interpret the OECD guidelines differently  Lack of consistency in the documentation required to be kept on a taxpayers transfer pricing file  Compliance burden for multinationals The Code will improve the situation by  Obviating multiple local documentation requirements  Reducing exposure to certain penalties for taxpayers  Providing increased clarity and conformity 1 Documentation 1.3 EU Code of Conduct

5 The “opt in” One set of standardised transfer pricing documents (EU Transfer Pricing Documentation – “EU TPD”) Applies to transactions involving EU enterprises and EU permanent establishments of non – EU enterprises Mitigation of documentation penalties Increased transfer pricing transparency Effect on compiling regional and domestic documentation 1 Documentation 1.3 EU Code of Conduct

6 A “masterfile" of standardised information and “Country-specific" standardised information for each relevant EU Member State Country-specific documentation supplements the masterfile to form the documentation file for the relevant EU Member State 1 Documentation 1.3 EU Code of Conduct

7 The table below illustrates the documentation required in the EU TPD: Minimum requirements of EU TPD BusinessGeneral description of businesses including changes from previous year (Masterfile) Detailed description of businesses including changes from previous year (Countryfile) StrategyGeneral description of business strategy including changes from previous year (Masterfile) Detailed description of business strategy including changes from previous year (Countryfile) 1 Documentation 1.3 EU Code of Conduct

8 Minimum requirements of EU TPD StructureGeneral description of group legal, organisational and operational structure, including organisation chart, list of group members and description of participation (Masterfile) General identification of associated enterprises engaged in controlled transactions involving EU enterprises (Countryfile) Transactions General description of controlled transactions involving associated EU enterprises; i.e. general description of transaction flows, invoice flows and amounts of transaction flows (Masterfile) Description and explanation of country-specific controlled transactions including transaction flows, invoice flows and amounts of transaction flows (Countryfile) 1 Documentation 1.3 EU Code of Conduct

9 Minimum requirements of EU TPD Functional analysisGeneral description of functions performed, risks assumed and a description of changes in respect of functions and risks compared to the previous tax year (Masterfile) Comparability analysis: characteristics of property and services; functional analysis; contractual terms; economic circumstances; and specific business strategies (Countryfile) Ownership of intangibles and royalties received and paid (Masterfile) 1 Documentation 1.3 EU Code of Conduct

10 Minimum requirements of EU TPD Transfer pricing details Group transfer pricing policy or description of group transfer pricing system, explaining arm’s length nature of transfer prices (Masterfile) Description of implementation and application of group’s inter- company transfer pricing policy (Countryfile) List of cost contribution agreements, APAs and transfer pricing rulings covering EU group members (Masterfile) Explanation of selection and application of TP method(s) (Countryfile) Relevant information on CUPs if available (Countryfile) 1 Documentation 1.3 EU Code of Conduct

11 Code does not qualify as EU law Incorporation into local law or adoption by individual tax authorities seems likely Potential increase in documentation burden for some countries e.g. UK Potential decrease in documentation burden for some countries (e.g. Germany) unlikely regarding Countryfile 1 Documentation 1.3 EU Code of Conduct

12 Advantages of opting in The benefits according to the European Commission - Reduction in compliance costs Reduction in exposure to documentation related penalties Decreased potential resort to competent authority procedure The opt in must be for all relevant EU entities 1 Documentation 1.3 EU Code of Conduct

13 Other advantages of opting in Good regional/global documentation and greater transparency will help taxpayers to  identify and address some of their more obvious tax exposures  better configure global and regional transfer pricing systems with business strategies  better recognise areas for potential improvements (tax and non-tax) to its supply chain 1 Documentation 1.3 EU Code of Conduct

14 4 Steps Gathering of information and documentation of facts Analysis of Intra-Group Transactions, Functional & Risk Analysis Search for comparables, database research, description of TP methods applied Harmonisation with advisors abroad, finalization, monitoring for updates Step 1Step 2 Step 3 Step 4 1 Documentation 1.4 Usual Steps for TP documentation

15 1 Documentation 1.5 Content of TP report Part I:Purpose and Scope of Transfer Pricing Documentation Part II:Documentation of the Facts 1. Group Description 1.1 Shareholders, Structure of the Group 1.2 History of the Group 1.3 Description of the Products/Services 1.4 Business Strategies 2. Analysis of the Industry and the Market 2.1 Overview of the Industry 2.2 Description of the Market (market shares etc.) 2.3 Competitors 2.4 Customers 2.5 Suppliers 2.6 Development of the Industry, the Market etc.

16 1 Documentation 1.5 Content of TP report 3. Analysis of Intra-Group Transactions 3.1 Overview of Intra-Group Transactions (incl. volumes, amounts) 3.2 Detailed Description of Intra-Group Transactions e.g. Research & Development, Production, Distribution, Financing, Services (incl. underlying agreements) 3.3 Pricing of Intra-Group Transactions 3.4 Overview of the essential Intangibles 4. Functional & Risk Analysis 4.1 Concept of the Functional & Risk Analysis 4.2 Functional & Risk Analysis regarding Intra-Group Transactions 5. Analysis of the Value Chain

17 1 Documentation 1.5 Content of TP report Part III:Transfer Pricing Methods 1.General Principles 2.Description of the Methods used 3.Description of the suitability of the method used 4.Description and Adjustments of comparable data (e.g. transactions with third parties, database analysis) 5.Other Circumstances affecting Transfer Prices Part IV:Conclusion Part V: Attachments (e. g. List of Contracts, APAs, database searches etc.) Note: In absence of material changes an update in the next year may be restricted to report changes from previous year

18 Measures in case of TP adjustment with (potential) double taxation: Appeal to local tax courts Mutual Agreement Procedure (MAP) based on tax treaty EU Arbitration Procedure (if both parties are resident in EU member states) Advance Pricing Agreement (APA) as roll back facility Precautionary measure to avoid double taxation: Bilateral or multilateral APA Unilateral APA (less effective) Documentation 2 Transfer Pricing Defense 2.1 Overview

19 Appeals in country where TP adjustment is made In most countries appeal filed with tax authorities or tax courts Tax payment normally not postponed Appeal may fail  no guarantee to get rid of double taxation  alternatively or simultaneously file Mutual Agreement Procedure Appeal usually interrupted when Mutual Agreement Procedure is initiated 2 Transfer Pricing Defense 2.2 Appeals

20 Taxpayer may file MAP when double taxation is expected, namely in case of TP adjustments (Article 25 of OECD Model Treaty) Deadline for filing in most Tax Treaties: 3 years Tax authorities usually will implement MAP if prerequisites are met Negotiations between states for finding a Mutual Agreement (MA) may take many years (on average 2 years) BUT: MA is not compulsory; success rate for MAP in EU is 85% If MA is found taxpayer may accept it or not; in the latter case normally he may continue appeal or law suit 2 Transfer Pricing Defense 2.3 Mutual Agreement Procedure (MAP)

21 MAP in Turkey Tax treaties with 61 countries Competent Authority: Double Taxation Agreements Division under Directorate General of Revenues No obligation for double taxation relief Most treaties allow 3 years filing period No domestic guidelines for MAPs No special formal requirements 2 Transfer Pricing Defense 2.3 Mutual Agreement Procedure (MAP)

22 Bilateral arbitration clauses in tax treaties (rare) EU Arbitration Convention (AC)  if MAP does not result in a MA after 2 years, arbitration council must be entrusted with case  within 6 months arbitrators suggest a MA  states may find different compromise or must accept the suggested MA after further 6 months Deadline for filing application is 3 years BENEFIT for taxpayer: compulsory avoidance of double taxation 2 Transfer Pricing Defense 2.4 EU Arbitration Procedure

23 APA for resolution or avoidance of disputes Possible way of dispute resolution as part of MAP under tax treaty  with retroactive effect (roll back) Mentioned in through OECD-G Guidance of OECD (1999) on how to conduct mutual agreement procedures involving APAs (“MAP APAs”) Domestic legislation in many states 2 Transfer Pricing Defense 2.5 Advance pricing agreements

24 Goal: avoid TP disputes regarding certain transactions for fixed period of time, as a rule for 3 years Parties: unilateral = taxpayer and local tax authorities bilateral = taxpayers in two states and both tax authorities multilateral = all taxpayers of a value chain and all tax authorities involved Note: unilateral APA does not avoid possible dispute in other state Prefiling procedure: unbinding discussion of potential APA (may be anonymous) 2 Transfer Pricing Defense 2.5 Advance pricing agreements

25 Subject of APA:  TP methods, ranges of mark-ups, royalty rates, cost allocation agreements etc.  common agreement on “critical assumptions” Problem: if critical assumptions are changing, tax authorities are no longer bound to the APA – risk for taxpayer  restriction of changing business 2 Transfer Pricing Defense 2.5 Advance pricing agreements

26 Draft reports on the attribution of profits to permanent establishments (early 2007 new versions)  Part I General Consideration  Part II Banking  Part III Global Trading  Part IV Insurance Changes of Articles 5 and 7 of the Model Tax Convention and related OECD Commentary (during 2007 draft version) 3 OECD Developments 3.1 Permanent Establishments

27 Income allocation between head office and permanent establishment (PE) PE treated like “separate entity” Royalty, rent or interest payments recognized between head office and PE Functional two step working hypothesis to determine the PE profit  determine functions and risks assumed and assets used by PE  attribute an arm’s length return for such functions, risks and assets as between comparable enterprises 3 OECD Developments 3.1 Permanent Establishments

28 Manual on Effective Mutual Agreement Procedures (MEMAP) draft of 2006 MEMAP intended as a guide to increase awareness of the MAP process and how it should function MEMAP identifies best practise how to deal with a MAP process without imposing binding rules upon Member countries 3 OECD Developments 3.2 MAP Manual

29 OECD invited practitioners to comment on profit methods Some important comments:  profit methods should have equal rank  taxpayer’s choice of method should be respected  tax authorities should be given access to all relevant information  profit split method ought to be changed to “profit and loss split method”  use of secret comparables ought to be rejected 3 OECD Developments 3.3 Discussion on Profit Methods

30 Consider TP aspects for all cross-border group transactions Look at tax aspects before prices are fixed and agreements are signed Prepare documentation in compliance with laws in Turkey and other countries Develop a group transfer pricing strategy in order to mitigate the group tax rate and to minimize tax risks Consider MAP as a way of dispute resolution 4 Conclusion