Attribution of Profits to Permanent Establishments Robin Saunders, Global Transfer Pricing Services, KPMG in the UK 25 January 2008 TRANSFER PRICING TAX

1 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Outline of Presentation Brief reminder of authorised OECD approach Key Issues for Part I Key Issues for Parts II and III Key Issues for Part IV

2 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Authorised OECD Approach Development of authorised approach  Several drafts and three public consultations since 8 February 2001  21 December 2006 – release of final version of parts I – III  22 August 2007 – release revised draft of part IV Functionally separate entity approach Two step approach to attribute profit 1) Use functional and factual analysis to hypothesize the PE as a distinct and separate enterprise 2) Application of the arm’s length principle to the hypothetical enterprise in accordance with the 1995 Guidelines (by analogy) First step is the most problematic Equality of treatment (same principles) not equality of outcome if branch and subsidiary are economically different

3 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Key Issues addressed by OECD in Part I 1) Importance of people functions 2) Intangibles 3) Head office costs

4 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (1) Importance of people functions Part I: “Significant people functions”  Risks attributed to PE are those for which the significant functions are performed by people in the PE  Economic ownership of assets attributed to PE where significant functions in respect of those assets performed by people in the PE Parts II – III still use “key entrepreneurial risk-taking functions”  Risks and assets more closely aligned in financial services  Part I language provides “more nuanced” approach for non-financial enterprises Same approach: attribution of assets, risk and capital driven by “people functions” All parts of report may be relevant to financial institutions  E.g. asset management - Part III relevant, non-financial activities – Part I relevant

5 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (2) Intangibles Location of risks and rewards determined by location of active decision-making and management  Cf capital and risk in Parts II-IV  Applies to both trade and marketing intangibles (but little specific guidance on marketing intangibles) Not just about royalties – attribution of arm’s length return to intangible  Return may already be in PE, just attribute share of costs?  Include intangible in profit split?  Licensing / royalty type arrangement?

6 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (3) Head office functions Two-step approach (Guidelines Chapter VII):  Determine whether intra-group services have in fact been rendered  Determine an arm’s length charge Arm’s length price may be less than cost in some cases Cost allocation is not acceptable  Unless arm’s length price is higher and taxing authority prepared to forgo full taxing rights over the income  Unless can have an internal “CCA”

7 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Key Issues addressed by OECD in Parts II & III 1) Importance of People Functions (KERT) 2) Risk Transfers 3) Capital attribution 4) Reward for Capital – Hedge Fund Model 5) Dependent Agent PEs 6) Symmetrical approach

8 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (1) Importance of the KERT Key entrepreneurial risk-taking functions (“KERTs”) are the main driver for attributing profits to financial institutions  Assets follow KERTs  Risk follows assets, capital follows risk Two kinds of KERT – these may be in different jurisdictions  Creation of a financial asset  Ongoing risk management of a financial asset Functional analysis required to identify and document the KERTs  Active, day-to-day decision making not high-level strategy  Report flexible about which functions are KERTs in specific situations

9 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (2) Risk Transfers Recognition of internal dealings but high threshold:  Must be ‘real and identifiable event’  Existence determined by functional analysis not books and records  Allocate risks where they are controlled, i.e. actively managed  Onus is on taxpayer to prove Parent/Sub: can have provision of guarantee H.O/Branch: no provision of guarantee recognised Impact on  use of credit derivatives: possible if supported by functional analysis  re-insurance in insurance industry: how active?

10 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (3) Capital Attribution Article 7 sets ceiling on source country taxing rights No single “correct” approach – need for flexibility  Number of possibilities as long as based on functions, assets, risks Two approved capital attribution approaches for financial institutions  Each requires measurement of risks  Regulatory based capital allocation approaches  Thin capitalisation Other methods: quasi-thin capitalisation  May be acceptable, but only as a safe harbour where authorised by the tax authority Little detailed guidance at OECD level on how to apply in practice

11 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (4) Reward for Capital No separate reward for capital in PE situation  Inconsistent with principles of authorised OECD approach  Possible between associated enterprises BUT ONLY IF no DAPE created Spectrum of possible rewards for capital: When can the hedge fund model be used?  Not authorised between a branch and head office  May be possible between associated enterprises BUT ONLY IF no DAPE created Hedge fund model as a good comparable?  May be appropriate for proprietary trading provided no PE exists  Pure client business: functionally different to hedge funds Profit split (inc. hedge fund model) Lending return

12 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (5) Dependent Agent P.E.s (“DAPE”) Sub A Booking Location/ Capital Provider Sub B Trader PARENT ? DAPE of A Profits/losses from principal positions ?

13 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (5) Dependent agent PE No change in existing Article 5(5) threshold BUT environment changing  Tax authorities increasingly view existing threshold as creating PEs in global trading  Fin 48: possibility of creating a DAPE is a “tax position” to evaluate and document Dependent agent PEs (“DAPE”) - General principle in Part I Report assumes a DAPE created under existing interpretation of Art.5(5)  OECD is considering clarifying Article 5(5) threshold  Business restructuring project Need to recognise two tax payers in PE jurisdiction  Administratively host authority may choose to collect tax from only one taxpayer

14 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. (6) Symmetrical Approach Risk of double taxation from having more than one authorised approach  Relieved by symmetry ? (now part of implementation) Symmetrical approach  Home country to follow authorised host country approach to treaty issues when relieving DT (provided result is consistent with arm’s length principle)  Host country method to be respected therefore no mechanism to ensure a single method can be used throughout the entity  More than one authorised approach is permitted so flexibility should not lead to DT, but: Limits for DT relief based on domestic law differences Double taxation relief rules (e.g. baskets etc) Still worth pursuing Mutual Agreement Procedure / Advance Pricing Agreements to achieve certainty over important issues  Fin 48: “more likely than not” test

15 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Key Issues addressed by OECD in Part IV Underwriting is generally the KERT of insurance risk assumption  “Underwriting” is broadly defined – Para 34 There is generally no KERT of ongoing risk management in insurance  OECD is not persuaded there is a sufficiently active function Intra-entity reinsurance (e.g. branch to H.O.) is generally not recognised  Risks are not transferred if there is no ongoing risk management KERT  External reinsurance premiums / recoveries may be allocated to PEs  The external reinsurance function may be a high-value service Investment assets and income are attributed to PEs to back liabilities and surplus following the KERT analysis  Thin capitalisation or capital attribution approaches

16 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Contacts John Neighbour Partner KPMG LLP (UK) +44 (0) Robin Saunders Senior Manager KPMG LLP (UK) +44 (0)

17 © 2008 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. This document is confidential and its circulation and use are restricted. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.Disclaimer The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.