1. Attorney Advertising Prior results do not guarantee a similar outcome. Copyright ©2011 Sullivan & Cromwell LLP The International Taxation of Goodwill and Other Intangibles Willard B. Taylor

2. 1 Copyright ©2011 Sullivan & Cromwell LLP What are intangibles for tax purposes? Intangible assets are generally divided between Intangibles, such as patents or intellectual property, that are legally owned or controlled by an enterprise and can be transferred separately from any other asset, and “Residual” intangibles, such as goodwill or going concern value, that ordinarily can be transferred only as part of the transfer of an entire business There are also “intangible” liabilities or responsibilities that may be transferred or assumed, such as market, supply, warranty or financial risks For example, the risk that a customer will default or that a product is defective and its repair is covered by a warranty

3. 2 Copyright ©2011 Sullivan & Cromwell LLP Why are the tax rules for intangibles important? Huge growth in multinational trade and also in the percentage of business assets represented by intangibles This is the reason for the OECD intangibles project announced in December 2010 Also, growth in the extent to which multinationals purposefully locate intangible assets and liabilities in low-tax countries i.e., countries in which the rate is lower than in the home country or the country of use And, finally, the rules and definitions are in flux – thus, e.g., the OECD intangibles project, the on-going revisions to the U.S. regulations, legislative proposals and court decisions Uncertainty with respect to so-called “business restructurings”

4. 3 Copyright ©2011 Sullivan & Cromwell LLP What are the tax issues? In the case of intangibles that are owned or controlled and are transferable separately, such as patents or other intellectual property, as opposed to goodwill What is the jurisdictional basis for taxing income from intangibles? Country of the owner’s residence? Or also country of use (or “source”)? In cross-border related-party transaction (e.g., a trademark license), how is the amount of income determined for tax purposes? By the use of the “arm’s length” standard? By “formulary” apportionment? And if there is disagreement between tax jurisdictions, how is double taxation avoided?

5. 4 Copyright ©2011 Sullivan & Cromwell LLP What are the tax issues? And at least in the U.S., the tax issues also include The application of subpart F (or anti-deferral rules) to income derived from intangibles by foreign subsidiaries of a U.S. parent Is the subsidiary’s income currently taxed in the U.S. ? Or is the tax deferred until the cash is repatriated to the parent? And when is there a repatriation? The application of the foreign tax credit rules, particularly in the case of royalties Continued

6. 5 Copyright ©2011 Sullivan & Cromwell LLP What are the tax issues? In the case of residual intangibles, such as “goodwill”, or going concern value, which is generally not transferable except as part of an entire business In the U.S., the recognition of gain when a business of a U.S. corporation is transferred to a foreign corporation in a “reorganization” or otherwise Gain may also be recognized when ownership of a transferable intangible is transferred to a foreign corporation in a reorganization or like transaction Likewise, transfers of intangibles by foreign corporations that are “successors” in certain expatriation transactions result in the recognition of gain or income That is, where the former shareholders of the U.S. corporation own 60% or more by value of the expatriated foreign corporation Continued

7. 6 Copyright ©2011 Sullivan & Cromwell LLP What are the tax issues? How should so-called “business restructurings” be treated? In such a transaction, for example, an enterprise may be stripped of responsibilities and its income correspondingly reduced (e.g., it becomes a “contract” manufacturer or distributor) Continued Foreign Parent U.S. “contract” mfg. subsidiary “Low-risk” distribution subsidiaries Low-taxed Foreign subsidiary business and distribution risks intangible property After Foreign Parent U.S. mfg. subsidiary U.S. and Foreign distribution subsidiaries Before Dividend Debt

8. 7 Copyright ©2011 Sullivan & Cromwell LLP Jurisdictional basis for taxation In the U.S. and other OECD countries the income is taxed to the owner (or owners) of the intangible property – it is “portfolio” not “business” income Jurisdiction given to the owner’s country of residence by Article 12 of the OECD Model Treaty Provides that income for the use of intangible property is exempt from source country tax if the owner is a resident of the other country Parent taxed in A Country B Country withholding on the royalty and B Country subsidiary allowed a deduction royalty A Country parent B Country subsidiary license

9. 8 Copyright ©2011 Sullivan & Cromwell LLP Jurisdictional basis for taxation Article 12 It does not apply to all payments – just those made for the use of specified intangibles,* and so it would not cover payments for distribution rights, for the development of designs that do not yet exist, or for services Endorsement and like fees paid to athletes and entertainers is an on- going issue – for services or the use of property? Article 12 seems to have no bearing on goodwill, going concern value, workforce-in-place and the like * Payments for the “…use of, or the right to use, any copyright of literary, artistic or scientific work including cinematogaph[ic] films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial commercial or scientific experience” Continued

10. 9 Copyright ©2011 Sullivan & Cromwell LLP Jurisdictional basis for taxation Article 12 is not accepted in all treaties – e.g., U.S.-India treaty allows 15-20% withholding tax on royalties and “fees for included services”, and the U.S.-Canadian treaty allows a 10% withholding tax and exempts altogether payments for motion pictures and for reproductions used in television For the Article 12 exemption to apply, the recipient of the income must be the “beneficial” owner in U.S. treaties this is supplemented by limitation on benefit articles and by rules with respect to payments made to hybrid entities Continued

11. 10 Copyright ©2011 Sullivan & Cromwell LLP Jurisdictional basis for taxation Income that falls outside of Article 12 would be dealt with in the OECD Model Treaty by the permanent establishment articles (Articles 5 and 7), the capital gains article (Article 13), or in the case of athletes and entertainers, by the separate treaty article that applies to their compensation (Article 17) Continued

12. 11 Copyright ©2011 Sullivan & Cromwell LLP “Simple” transfer pricing If the owner and the user (or users) of a transferable intangible asset are related (or “associated”) and in different countries, there is a transfer pricing issue Is the owner’s compensation too little? Or too much? royalty Parent Foreign Subsidiary license

13. 12 Copyright ©2011 Sullivan & Cromwell LLP U.S. transfer pricing regulations The OECD transfer pricing guidelines and the U.S. regulations have consistently used the arm’s length standard to determine the way income is divided “a taxpayer dealing at arm’s length with an uncontrolled taxpayer” and thus they have consistently rejected formulary apportionment But the absence of comparables is a serious problem in applying the arm’s length standard and the increasing emphasis on “profit split” methods may signal a gradual move towards something like formulary apportionment

14. 13 Copyright ©2011 Sullivan & Cromwell LLP U.S. transfer pricing regulations Under U.S. regulations, there is a broad definition of intangibles – in addition to patents, copyrights, trademarks and the like, includes methods, programs, systems, procedures, studies, and so on but only if the item has substantial value independent of the services of individual persons unclear whether intangibles in the transfer pricing context include goodwill, going concern value or workforce-in-place The owner of an intangible is the person who is the legal owner under local or contract law or, failing that, the person with “control” Continued

15. 14 Copyright ©2011 Sullivan & Cromwell LLP U.S. transfer pricing regulations Absent “sufficiently comparable” transactions, use the “best” method to determine what is comparable – the “most reliable measure” of an arm’s length result Methods are the comparable uncontrolled transaction, comparable profits, profit split methods, and an “unspecified” method – a method that is not listed but which provides the most reliable measure Regulations contemplate cost-sharing arrangements in which related parties agree in advance to share costs of developing, and the benefits of, intangibles Continued

16. 15 Copyright ©2011 Sullivan & Cromwell LLP U.S. transfer pricing regulations Apart from regulations, the U.S. has an advance pricing agreement program which seeks to resolve the choice of a method in advance the results, however, are not public Services are dealt with separately by “controlled” service regulations, which have their own “methods” for determining what is at arm’s length generally, except for routine services, they reject the cost-plus method Continued

17. 16 Copyright ©2011 Sullivan & Cromwell LLP OECD transfer pricing guidelines OECD has transfer pricing “guidelines” – not rules, as such – with respect to intangibles Revised and reissued in July 2010, but with an announcement shortly thereafter that there would likely be a project on intangibles to further update that part of the guidelines U.S. and OECD rules converge in many ways – e.g., the arm’s length standard, emphasis on comparability, permitted methods The U.S. would say it is in this regard the leader But there are important differences – e.g., The deference given by the OECD guidelines to the terms of contracts between related parties and the separate rules on “business restructurings”

18. 17 Copyright ©2011 Sullivan & Cromwell LLP Income tax treaties OECD Model Treaty (Article 9) and U.S. treaties allow the tax authorities to adjust profits – to “re-write the accounts of the enterprises” – where transactions are not at arm’s length thus the U.S. regulations, as well as what is contemplated by the OECD transfer pricing guidelines, are consistent with treaty obligations If there is an adjustment by one state, and it results in double taxation, the other state is to make an appropriate adjustment, but it need do so only if agrees with the adjustment If not, the only resort is to the mutual agreement or competent authority provision of the treaty (Article 25 in the case of the OECD Model)

19. 18 Copyright ©2011 Sullivan & Cromwell LLP Do the current transfer pricing, subpart F and related foreign tax credit rules “work”? At least in the U.S., there is a seeming consensus that the transfer pricing, subpart F and foreign tax credit rules are, from the tax administration’s point of view, “broken” If so, intangibles are a major reason – because of their mobility, the difficulty under the arm’s length approach of finding comparables, and the lack of clear definitions and rules Together with the “stripping” of income through deductible payments, this has led to the accumulation of a huge amount of untaxed cash in low- or no-tax foreign subsidiaries of U.S. corporations – more than $1 trillion Resulting in the so-called “lock out” effect And the rules with respect to the circumstances in which the cash will be treated as repatriated to the U.S. parent, and taxed, are also imperfect

20. 19 Copyright ©2011 Sullivan & Cromwell LLP Do the current transfer pricing, subpart F and related foreign tax credit rules “work”? Much less focus on the effect on “inward” investment by foreign corporations where There are no subpart F rules to “back up” the transfer pricing rules Although there are rules on the deductibility of interest paid to (or on a loan guaranteed by) a related foreign person, and there may in the future be rules on reinsurance premiums paid to related foreign reinsurers Continued

21. 20 Copyright ©2011 Sullivan & Cromwell LLP How to treat transfers of intangible assets and liabilities in “business restructurings” or otherwise Is the definition of an intangible for this purpose broader (e.g., does it include work-force-in place, goodwill and going concern value)? Foreign Parent U.S. mfg. subsidiary U.S. and Foreign distribution subsidiaries Before Foreign Parent U.S. “contract” mfg. subsidiary “Low-risk” distribution subsidiaries Low-taxed Foreign subsidiary business and distribution risks intangible property After Debt Cross-border business restructuring

22. 21 Copyright ©2011 Sullivan & Cromwell LLP Cross-border business restructuring In these transactions, the financial and other “intangible” liabilities or responsibilities of an enterprise are assumed by a related person and the payments to the enterprise for what it does are correspondingly reduced Should there be a transfer pricing adjustment, or a taxable disposition of goodwill, so long as each transaction is at arm’s length? i.e., so long as the liabilities assumed do in value offset the reduction in profitability of the U.S. manufacturing subsidiary? Continued

23. 22 Copyright ©2011 Sullivan & Cromwell LLP Other issues – subpart F and foreign tax credit rules Is the income of the foreign subsidiary currently taxable in the U.S.? Subpart F rules currently tax passive income of a foreign subsidiary (a “controlled foreign corporation”), including royalties, but many exceptions – e.g., active business royalties royalties and certain other payments made by one CFC to another, active financing income Ability to use the check the box regulations to create fictitious payments Additionally, the foreign tax credit rules may operate to eliminate U.S. tax on untaxed foreign income – in particular, royalties

24. 23 Copyright ©2011 Sullivan & Cromwell LLP Other issues – subpart F and foreign tax credit rules Thus, the subpart F rules do not adequately “back up” transfer pricing rules leading some to say that the present U.S. system is more biased towards multinationals than an exemption, or territorial, system in which no deduction would be allowed for foreign losses or for expenses related to exempt income A dividend, which includes “investments” in United States property, would be income to the U.S. parent, with a foreign tax credit for foreign income taxes on the repatriated earnings But there have been “indirect” repatriations – e.g., the use of cash to buy U.S. parent stock for use in an acquisition – which have avoided the repatriation rules Continued

25. 24 Copyright ©2011 Sullivan & Cromwell LLP Other issues – treaties and subpart F, tax credit and outbound transfer rules How do income tax treaties fit into these rules? U.S. treaties, like the OECD Model, generally do not constrain subpart F and like rules that currently tax income of foreign corporations to their shareholders, or rules that require the recognition of gain or income on cross- border transfers of intangible property

26. 25 Copyright ©2011 Sullivan & Cromwell LLP What is wrong with the U.S. rules and is there a solution? Move from a residence-based worldwide system to a territorial/exemption system in which deductions attributable to foreign income would not be allowed? Or just move seriously towards worldwide system, i.e., eliminate any exclusions from current taxation of the income of a foreign subsidiary? Amend the transfer pricing guidelines and rules? Move towards profit split/apportionment methods? Or would that be worse? Tighten the controlled foreign corporation and foreign tax credit rules and rely on those rules as a backstop to transfer pricing? What about “inward” investment?

27. 26 Copyright ©2011 Sullivan & Cromwell LLP What is wrong with the U.S. rules and is there a solution? U.S. Administration’s fiscal 2012 revenue proposals Currently tax, under subpart F, “excess income” of a low- taxed controlled foreign corporation from intangibles transferred directly or indirectly by a related U.S. person “Excess income” would be income in excess of net income plus a percentage markup Transfers would include transfers in cost-sharing agreements, as well as licenses “Clarify” that Intangibles for all purposes include workforce in place, goodwill and going concern value Value may be based on the prices or profits that would be realized in a realistic alternative to the controlled transaction Continued

28. 27 Copyright ©2011 Sullivan & Cromwell LLP What is wrong with the U.S. rules and is there a solution? U.S. Administration’s fiscal 2012 revenue proposals Defer the deduction for interest expenses attributable to untaxed foreign income Determine the foreign tax credit on a pooling basis In the case of inward investment Further interest deductibility, but only in the case of expatriated entities, i.e., corporations that were formerly U.S. incorporated Disallow a deduction for certain untaxed reinsurance premiums paid to foreign affiliates Continued

29. 28 Copyright ©2011 Sullivan & Cromwell LLP Costs of developing Like many countries, the U.S. provides incentives to locate the development of intangibles in the U.S. including A research and development tax credit, which the Administration proposes to simplify, increase and make permanent Expense allocation rules that in effect mitigate the impact on the foreign tax credit of domestic research and development costs