TA X R E F E R E N C E L I B R A RY N O 1 0 8

Published in association with:

Deloitte Korea
Gowling WLG
Fenwick & West
Tax Partner AG – Taxand Switzerland

Transfer Pricing 18th edition

Transfer Pricing
03 Canada
IP migration strategies – pre and post BEPS
BEPS aims to prevent aggressive profit-shifting strategies to better align transfer pricing outcomes
with value creation. In this paper, Dale Hill, a partner at Gowling WLG, examines BEPS’s appli-
cation to the transfer pricing aspects of intangibles and the impact on tax-motivated IP migration
strategies.

10 South Korea
There is more to BEPS than meets the eye
Much lies beneath the surface of BEPS. How will BEPS affect Korean multinationals and what do
MNEs need to learn? Tae Hyung Kim, partner and senior transfer pricing economist at Deloitte
Korea, explains exactly what multinationals must consider and what they should fear.

14 Switzerland
Intangibles in a post BEPS world
The framework for analysing intercompany transactions involving intangibles is examined by
Hendrik Blankenstein and Caterina Colling Russo at Tax Partner AG – Taxand Switzerland.
Does the new DEMPE analysis benefit MNEs and tax authorities or simply confuse matters, result-
ing in an increase of intangibles-related disputes?

19 US
Responding to the changes in the transfer pricing landscape
The Internal Revenue Service appears to be strengthening its stand on aggregating transactions and
applying economic substance rationales to override related-party contracts. David Forst and Larissa
Neumann of Fenwick & West discuss US developments including the IRS and Treasury
Department-issued 482 Temporary Regulations.

W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M 1
EDITORIAL

BEPS: 8 Bouverie Street

The endgame
London EC4Y 8AX UK
Tel: +44 20 7779 8308
Fax: +44 20 7779 8500
Managing editor, TPWeek.com Caroline Byrne
caroline.byrne@euromoneyplc.com
Reporter, TPWeek.com Joelle Jefferis
joelle.jefferis@euromoneyplc.com
Managing editor Ralph Cunningham
rcunningham@euromoneyplc.com
Reporter Joe Stanley-Smith
joseph.stanley-smith@euromoneyplc.com
he boldest initiative in transfer pricing history entered the home-

T stretch in October 2015 with the release of the OECD’s final report
on its base erosion and profit shifting (BEPS) project. The reverbera-
tions are being felt across North America, Europe, Asia and beyond.
Reporter Amelia Schwanke
amelia.schwanke@euromoneyplc.com
Production editor João Fernandes
jfernandes@euromoneyplc.com
Multinational enterprises will soon need to provide tax authorities with PublisherOliver Watkins
details of almost every facet of their business through the master file, local owatkins@euromoneyplc.com
file and country-by-country reports: key profit drivers, global value chains, Associate publisher Andrew Tappin
transfer pricing policies for major services and intangibles, MNE financial atappin@euromoneyplc.com
statements, and more. Is there any doubt about who has the upper hand: Online associate publisher Megan Poundall
taxpayers or tax authorities? mpoundall@euromoneyplc.com
The objective of the OECD’s plan is clear: combat aggressive profit- Senior marketing executive Sophie Vipond
shifting strategies. BEPS was designed to ensure MNEs reveal profits in sophie.vipond@euromoneyplc.com
jurisdictions based on assets, risks and actual functions. It is unsurprising Graduate marketing trainee Anna Sheehan
anna.sheehan@euromoneyplc.com
then, that BEPS is shaking up countries and companies.
While tax officials and legislators worldwide are moving quickly, many Subscriptions manager Nick Burroughs
nburroughs@euromoneyplc.com
companies are moving cautiously. Some are concerned about how author-
Divisional director Greg Kilminster
ities will handle tax data. Others worry about confidentiality breaches or
the risk of audits and double taxation But a sense of urgency is needed, © Euromoney Trading Limited, 2016. The copyright of all editorial
otherwise, MNEs risk penalties, reputational risks and additional taxes. matter appearing in this Review is reserved by the publisher.
In his candid assessment of the tension between taxpayers and tax No matter contained herein may be reproduced, duplicated or
authorities, Tae Hyung Kim, a partner at Deloitte Korea, explains what copied by any means without the prior consent of the holder of the
copyright, requests for which should be addressed to the publisher.
multinationals must consider and what they should fear. Although Euromoney Trading Limited has made every effort to
Hendrik Blankenstein and Caterina Colling Russo of Tax Partner AG ensure the accuracy of this publication, neither it nor any
– Taxand Switzerland examine whether the newly introduced DEMPE contributor can accept any legal responsibility whatsoever for
analysis benefits MNEs and tax authorities, or whether it will just con- consequences that may arise from errors or omissions, or any
opinions or advice given. This publication is not a substitute for
fuse matters and result in an increase of intangibles-related transfer pric- professional advice on specific transactions.
ing disputes.
Dale Hill, a partner at Gowling WLG in Canada, considers the applica- Directors John Botts (Chairman), Andrew Rashbass (CEO),
tion of BEPS guidelines to the transfer pricing aspects of intangibles and Sir Patrick Sergeant, The Viscount Rothermere, Colin Jones,
Martin Morgan, David Pritchard, Andrew Ballingal, Tristan Hillgarth
the impact on tax-motivated IP migration strategies. His insightful analysis
encompasses both pre- and post-BEPS strategies. International Tax Review is published 10 times a year by Euromoney
Finally, questions remain about how much change the US is prepared Trading Limited.
to implement, but the OECD’s recommendations are without doubt hav- This publication is not included in the CLA license.
ing an impact. David Forst and Larissa Neumann of Fenwick & West dis- Copying without permission of the publisher is prohibited
cuss US developments including the IRS and Treasury Department-issued ISSN 0958-7594
482 temporary regulations.
Customer services: +44 20 7779 8610
Caroline Byrne UK subscription hotline: +44 20 7779 8999
Managing editor, TPWeek.com US subscription hotline: +1 800 437 9997

2 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M

IP migration strategies –
pre-and post-BEPS
BEPS aims to prevent
aggressive profit-
shifting strategies to
better align transfer
pricing outcomes with
value creation. In this
paper, Dale Hill, a
partner at Gowling
WLG, examines
BEPS’s application to
the transfer pricing
aspects of intangibles
and the impact on tax-
motivated IP migration
strategies.
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
CANADA
he largest initiative the transfer pricing world has seen, since the intro-
T duction of the Organisation for Economic Cooperation and
Development’s (OECD) Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations (Current TP
Guidelines), is in its final stages and will result in material changes in the
way the global operations of corporate organisations are structured and
international transactions are reported.
On October 5 2015, the OECD released the final report of its 15-point
Action Plan on Base Erosion and Profit Shifting (BEPS). The BEPS Action
Plan was an ambitious project that addressed a number of concerns relating
to international corporate tax planning. Actions 8 to 10 and Action 13 deal
specifically with transfer pricing concerns and, in addition to the introduc-
tion of Country-by-Country Reporting (CBCR), contain significant
revised guidance in the form of amendments to the Current TP Guidelines
(Amended TP Guidelines).
In brief, the OECD’s BEPS initiative, as it pertains to transfer pricing,
attempts to prevent aggressive profit-shifting strategies by amending the
Current TP Guidelines to better align transfer pricing outcomes with value
creation. This is accomplished by placing more emphasis on the allocation
of profits to the jurisdiction where substantive functions are performed,
including the control functions related to risks assumed and capital
employed. The Amended TP Guidelines, intended to be clarifying in
nature and not a departure from the arm’s length principle as enshrined in
the Current TP Guidelines, now provide the tools and support the Canada
Revenue Agency (CRA), and presumably other tax administrations, need
to successfully challenge tax-motivated transfer pricing strategies where
substantive people functions are not transferred with the intangible prop-
erty (IP).
This paper examines the OECD BEPS initiative as it applies to the
transfer pricing aspects of intangibles and the impact on tax-motivated IP
migration strategies. It is widely recognised that the primary objective of
an MNE is to maximise profits and, as such, MNEs are constantly evaluat-
ing their international operations in an effort to maximise revenues and
minimise costs, including tax expenses. Historically, where the commercial
opportunity existed, companies often adopted IP migration transfer pric-
ing strategies that allocated significant profits to lower-tax jurisdictions. In
the most extreme cases, no or minimal functionality (i.e. no employees)
was transferred with the IP (e.g. cash box companies). Many of these
strategies, and the tax savings that arose from them, whether rightfully or
3
CANADA
wrongfully, were thought to be legally effective and in line
with the arm’s length principle as described in the Current TP
Guidelines. Such tax-motivated IP migration cases have often
come under careful scrutiny by tax administrations.
Notwithstanding such scrutiny, there was a lack of clear guid-
ance and policy application by the CRA’s Audit Division,
Appeals Directorate and Competent Authority. In many cases
the CRA accepted these structures as they were generally
thought to be tax efficient and in line with the arm’s length
principle regardless that significant profits were allocated to
that lower tax jurisdiction. This is about to change
BEPS changes to current TP guidelines in respect to
intangibles
The OECD’s BEPS Action Plan was an enormous undertak-
ing covering many areas of international tax and only time will
tell what the collective impact will be as a consequence of all
the final report recommendations. However, what is widely
agreed upon in the international tax community is that the
most immediate, and likely most significant, impact from the
BEPS project will be in the world of transfer pricing. The new
CbCR and the Amended TP Guidelines are reality and are
here to stay.
The OECD’s work related to transfer pricing under the
BEPS Action Plan focused on three key areas. Action 8
looked at transfer pricing issues related to transactions involv-
ing intangibles, Action 9 considered the contractual alloca-
tion of risks and the resulting allocation of profits to those
risks, and Action 10 focused on other high-risk areas includ-
ing the possibility of re-characterisations where transactions
were not commercially rational. The Amended TP Guidelines
arising as a consequence of the OECD’s work on Actions 8 to
10 are significant and amend several chapters and sections of
the Current TP Guidelines. The following is a brief summary
of the new guidance dealing with intangibles:
• Legal ownership of intangibles by an associated enterprise
alone does not determine entitlement to returns from the
exploitation of intangibles;
• Associated enterprises performing important value-creat-
ing functions related to the development, enhancement,
maintenance, protection and exploitation (DEMPE) of the
intangibles can expect appropriate remuneration;
• An associated enterprise assuming risk in relation to the
DEMPE of the intangibles must exercise control over the
risks and have the financial capacity to assume the risks
including the very specific and meaningful control require-
ment;
• Entitlement of any member of the MNE group to profit or
loss relating to differences between actual and expected
profits will depend on which entity or entities assume(s)
the risks that caused these differences and whether the
entity or entities are performing the important functions in
relation to the DEMPE of the intangibles;
4 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
• An associated enterprise providing funding and assuming
the related financial risks, but not performing any func-
tions relating to the intangible, could generally only expect
a risk-adjusted return on its funding; and
• If the associated enterprise providing funding does not
exercise control over the financial risks associated with the
funding, then it is entitled to no more than a risk-free
return.
An example of the new approach
To see how the allocation of profits from IP transfers differ
between a pre- and post-BEPS world, consider example 17
from the Amended TP Guidelines. In the example, the fol-
lowing facts/assumptions are assumed:
1. Parent is a large pharmaceutical company.
2. Parent conducts its operations in country X.
3. Parent regularly retains independent (unrelated) contract
research organisations (CROs) for research and develop-
ment (R&D) activities, including designing and conduct-
ing clinical trials.
4. CROs are not engaged in the blue sky research to identify
new compounds.
5. When retained, Parent actively participates with CRO
engaged in clinical research activities.
6. CROs are paid a negotiated fee for services and do not
have an ongoing interest in the profits.
7. Parent transfers patents related to Product to Subsidiary
operating in country Y.
8. Product is early stage pharmaceutical drug (high risk, low
probability of commercialisation).
9. Payment based on anticipated future cash flows – expect-
ed cash flow discounted by appropriate discount rate.
10. Subsidiary has no technical personnel for ongoing
research activities.
11. Subsidiary contracts with Parent to carry out research
related to Product.
12. Subsidiary funds all Product research, assumes risk, and
pays Parent based on cost plus margins earned by similar
CROs.
The fact pattern given above is the classic example of an
early stage pharmaceutical company wanting to realise future
profits in a low-tax jurisdiction. In the pre-BEPS world, a sig-
nificant portion of the profits would have moved to country
Y. It was generally recognised that given the Subsidiary was
the legal owner, it was entitled to any excess profit or loss after
paying routine amounts for the R&D activities, even where
the important value-creating functions of the IP did not take
place in the Subsidiary’s country. The transfer of the IP would
have been done at a low value (although arm’s length) as the
prospects of successful commercialisation were very uncertain
at the time of the transfer. In regards to future development
of the intangible property, Parent, as a service provider, would
have been entitled to a cost plus mark-up on costs incurred.

In a post-BEPS world, less emphasis is placed on legal
ownership and more on economic aspects of substance. In
the example above, Parent controls functions and manages
patent risks owned by Subsidiary and is entitled to compen-
sation. The Amended TP Guidelines, including the analysis
to example 17, will support that Parent’s compensation is
not appropriately recognised by the profits earned by a
CRO. Parent’s transactions with CROs are not comparable
to the Subsidiary/Parent arrangement given that the func-
tional profiles differ, i.e. parent is in control of function and
is the more appropriate party to assume the risks of success
or failure. While Subsidiary legally owns the patents it lacks
the capability to control research risks while Parent per-
forms key decision making functions and thus should be
appropriately compensated.
Clearly there has been a fundamental shift in the way we
look at the division of profits due to the introduction of
BEPS. In a pre-BEPS environment, Subsidiary would be bet-
ter able to keep profits given it legally owned the intangibles
and paid arm’s length prices for development functions.
Post-BEPS, it is clear this will change with an emphasis on
functions, including control of those functions and risks.
Moving intangible property offshore in a transfer pricing
setting – pre-BEPS & post-BEPS
Intangibles are becoming an increasingly valuable component
of a company’s value. Intangibles often account for a larger
stake in an enterprise’s value than traditional tangible assets.
When you factor in the mobility of these assets, it is not a sur-
prise that IP migration strategies have frequently been relied
upon to move profit-generating assets to lower tax jurisdic-
tions. However, there are other legitimate reasons for migrat-
ing intangibles, including:
• Protection of intangible property
• Capital funding
• Sharing in intangible development risks
• Tax credit issues
From a tax perspective, during both the pre-BEPS and
post-BEPS era, moving IP from one jurisdiction to another,
including lower tax jurisdictions, can be justified and legally
tax effective if the corresponding functions, assets and risks
are moved with the IP. Historically, the legal owner took all,
or a material portion of, the residual profits after routine prof-
its were paid to entities that performed functions related to
the DEMPE of the intangibles and the management of the
risk. In the post-BEPS environment however, a shift has
occurred in that people functions, particularly controlling
functions related to the DEMPE of the intangibles and con-
trolling functions regarding the assumption and mitigation of
risk, have far greater value than legal ownership, direct fund-
ing and contractual assumption of risk.
The old transfer pricing adage of “functions, assets and
risk” is now misleading as functionality seems to be highly
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
CANADA
Dale Hill
Partner, Tax Services – National Leader,
Transfer Pricing & Competent Authority
Group
Gowling WLG
Office: +1 (613) 786 0102
Fax: +1 (613) 788 3473
dale.hill@gowlingwlg.com
Dale Hill is a partner in Gowling WLG’s Ottawa office and is the
national leader of the Gowling WLG’s Transfer Pricing and
Competent Authority team. Dale works in conjunction with the
firm’s national tax practice group to help organisations optimise
their global tax position and reduce exposure to unfavourable
audit assessments through proper tax planning and implementa-
tion strategies. Dale’s specialty is audit defence and dispute res-
olution with many countries around the world.
In addition to Dale’s audit defence work, he also oversees the
group’s transfer pricing documentation and Advanced Pricing
Agreement (APA) practice and is actively involved in providing liti-
gation advice to the firm clients from a tax perspective. Dale has
worked in a variety of industries including, but not limited to,
pharmaceuticals, auto, construction, consumer durables and
computer software industries.
Dale’s ability to solve contentious issues stems from his vast
experience working at the Canada Revenue Agency (CRA) at a
senior level. Prior to joining Gowling WLG in 2005, Dale was
involved in international transfer pricing and tax avoidance with
the CRA for 16 years. During his tenure as a senior manager with
the CRA’s International Tax Directorate, he participated in more
than 40 APAs with numerous countries, as well as hundreds of
Competent Authority requests relating to international transfer
pricing adjustments involving a vast array of issues. He is also
experienced in a number of other international tax areas, includ-
ing interest deductibility, guarantee fees, imputed interest, notion-
al expenses, penalties and appeals. Dale has been successful in
resolving a number of controversial audit issues through negotia-
tions with various tax authorities in a number of countries
around the world.
Dale’s expertise has been recognised many times by various
institutions. In particular, his group was awarded with Canada
Transfer Pricing Firm of the year award by International Tax
Review for the years 2011, 2013, and 2015. He acquired his CPA
and CFP designations in 1991 and 1995, respectively, and com-
pleted the CICA in-depth tax course in 1999.
5
CANADA
relevant in all three of those factors. In other words, if transfer
pricing is supposed to be based on economic reality, does eco-
nomic reality support allocation of residual profits to purely
functions (e.g. labor) rather than ownership (e.g. capital)?
This is one of the main reasons there is debate in the interna-
tional tax community, and particularly in the Canadian tax
community, regarding whether the Amended TP Guidelines
are clarifying in nature or whether they constitute a funda-
mental change to the arm’s length principle. Unfortunately,
this debate is a moot point because the opinion of the OECD
and tax administrations, which ultimately prevails over that of
the taxpayer, is that the revised guidelines are clarifying in
nature and not a fundamental departure from the arm’s
length principle. The CRA has confirmed its view that the
revisions are clarifying in nature.
In the post-BEPS world, if tax-motivated IP migration
strategies are to be carried out in an acceptable manner, it is
imperative that substantive functions be transferred with the
intangibles. From the OECD’s perspective, its BEPS initiative
successfully eliminates the tax benefits behind cash box compa-
nies and other structures that were pushing the envelope with
respect to lack of functionality in the lower tax jurisdiction.
Rectifying pre-BEPS structures that are inconsistent with the
amended TP guidelines
Many enterprises are concerned about how taxing authorities,
such as the CRA, will treat existing tax structures involving IP
migration that were created before BEPS. As mentioned
above, the Amended TP Guidelines are considered by the
OECD and the CRA to be clarifying in nature and are, for all
intent and purpose, retroactive in effect. If taxpayers believe
that their existing structures are not consistent with the
Amended TP Guidelines and make no attempt to rectify
them, they run the risk of being exposed to transfer pricing
adjustments should they be audited by the CRA. In the event
taxpayers decide to rectify the situation on a prospective basis
only (e.g. by amending their transfer pricing documentation
to reflect the Amended TP Guidelines for future years), this
could red flag problems and deficiencies to the CRA with
respect to their filed taxation years.
To date, the CRA hasn’t made public statements regard-
ing possible relief for taxpayers trying to rectify existing IP
migration structures that have been reported in a manner
that is inconsistent with the Amended TP Guidelines. In
the author’s view, this silence, or lack of concern, is unfor-
tunate considering the significance of the changes which
are, arguably, beyond clarifying in nature. What is more
troublesome is the CRA’s position that these changes are
clarifying in nature and retroactive in effect despite having
agreed to countless audit, appeal and mutual agreement
settlements over the years on IP migration structures, sup-
posedly on a “principled” analysis of the arm’s length prin-
ciple, in a manner that is not consistent with the Amended
6 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
TP Guidelines. In other words, tax administrations have
routinely settled transfer pricing cases in a manner that is
not consistent with the Amended TP Guidelines and have
allowed varying degrees of profits to be reported in lower-
tax jurisdictions where little functionality has taken place.
In the absence of guidance from the CRA on this matter,
taxpayers should proceed with caution before deciding on a
rectification strategy. Canadian taxpayers can file amended
tax returns for those open taxation years where their
reported transfer prices are inconsistent with the Amended
TP Guidelines. However, if the taxpayer’s pending upward
transfer pricing adjustments for filed taxation years are sig-
nificant and subject to possible penalties, taxpayers may
consider the CRA’s voluntary disclosure program (VDP).
The CRA has little experience in its VDP with respect to
transfer pricing cases and the waiver of transfer pricing
penalties, so there is some uncertainty in this avenue of
recourse. Also, Canada’s VDP has stringent conditions for
eligibility that often prohibit taxpayers from applying, par-
ticularly those taxpayers who are under constant audit
activity by CRA. Taxpayers could also consider applying for
an Advanced Pricing Agreement (APA) which assists tax-
payers in determining transfer pricing methodologies for
prospective years (generally three to five years). One of the
benefits of the CRA’s APA program is the ability for taxpay-
ers to ask to apply the terms and conditions of an APA
retroactively to non-statute-barred taxation years (i.e., an
APA rollback). Where APA rollbacks are accepted, the tax-
payer will not be subject to transfer pricing penalties.
Taxpayers would be well advised to seek tax counsel
before deciding on first, whether self-rectification of unau-
dited filed years is advisable and, if so, what specific course
of action to take.
Post-BEPS – is there now more uncertainty?
As a consequence of the BEPS project and the resulting
Amended TP Guidelines, profits must be aligned with the
location of value creation. There is no ambiguity in the
OECD’s message to the tax community on this issue.
However, the guidance from the OECD, including exam-
ple 17, does not provide much in the way of how the actual
intercompany transfer prices should be documented. In a
typical IP migration strategy, there is often only two inter-
company transactions taking place: i) the initial transfer of
the IP to the subsidiary located in the lower tax jurisdic-
tion; and ii) the intercompany R&D service contract. The
final sale of the IP or the ultimate exploitation of the IP by
the foreign subsidiary will be done with arm’s length par-
ties (i.e. customers). In the event the CRA decides not to
recharacterise the transaction, the first intercompany trans-
action will simply involve valuation issues. With regards to
the second intercompany transaction, the OECD expects
future revenues to be properly allocated to the parent

company for its efforts in contributing to the value of the
IP. However, in the absence of guidance from the OECD
and tax administrations on how this should be document-
ed, taxpayers are left in the dark.
From a practical point of view, profits should be set such
that the simpler of the two parties be given a routine return
while the more complex party receives the residual
profits/losses if such profits materialise. The profits attrib-
utable to each party will depend on the functions per-
formed, assets utilised, and risks assumed by each party. If
the subsidiary is simply the holder of IP with no correspon-
ding functions, it may only be entitled to an unadjusted
return on capital. If the subsidiary performs routine func-
tions in addition to holding the IP, a risk adjustment return
on capital may be warranted.
The decision to allocate excess profits/losses to the par-
ent may cause audit controversy for a number of reasons. It
is the author’s experience that governments are risk averse
and want to see some level of compensation in the immedi-
ate term even though they may only be entitled to larger
atypical profits or losses when the intangibles are fully
utilised. Consider the possibility that, in the example above,
the IP generated large losses in the initial post transfer
years. Will the CRA allow the parent company, performing
and controlling key functions and risks, to report the losses
even though it did not own the IP and is simply a service
provider according to the intercompany R&D service con-
tract? It’s doubtful.
Tax authorities such as the CRA may have difficulty
accepting that a service provider should not receive at least
a cost plus mark-up on services it renders (in addition to
some share of the profits if they materialise). It is very likely
that setting intercompany pricing on an intercompany serv-
ice agreement such that the parent company service
provider incurs losses will trigger an audit. The guidance, in
our view, does not shed sufficient light on the mechanics of
profit allocation and seems to add more confusion to an
already uncertain landscape. Example 17 of the Amended
TP Guidelines is a common IP migration structure but it is
highly likely that the annual reporting of the service con-
tract during the start-up years where no profits are being
realised will be treated differently between taxpayers and
tax administrations until further guidance is developed.
The Amended TP Guidelines will likely result in fewer
companies carrying out IP migration strategies, which was
one of the unwritten goals of the BEPS initiative.
Consequently, the OECD and tax authorities may not be
overly concerned about its lack of guidance on reporting
issues during the start-up years where the legal ownership of
IP was in fact transferred offshore. This is unfortunate
because some IP migration strategies involving low-tax juris-
dictions may still be carried out, regardless of the Amended
TP Guidelines, without the initial movement of functions.
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
CANADA
This could, for example, be an acceptable strategy where a
start-up company wants to keep its options open (e.g. relo-
cate the appropriate DEMPE functions to the jurisdiction
that holds legal title of the intangibles) once it has a better
idea of the potential value and income earning capacity of the
intangible. Even though the Amended TP Guidelines will
need to be considered regarding the lack of functionality in
the low tax jurisdiction in that initial start-up period, there
could be future departure tax savings by transferring owner-
ship of the intangibles at the earliest stage possible.
Conclusions
The BEPS initiative was designed to ensure multinational
corporations report profits in jurisdictions based on actual
functions, assets and risks and to combat aggressive tax
planning structures. The new guidance moves away from
placing significant emphasis on legal ownership and
towards economic substance and control. The introduction
of the Amended TP Guidelines will provide taxing author-
ities, such as the CRA, more tools to raise and support
transfer pricing adjustments. Consequently, taxpayers must
be aware of this new guidance before carryout out any IP
migration planning.
From a Canadian perspective, an unfortunate aspect of the
BEPS project is the lack of guidance provided by CRA with
respect to these new guidelines. In the author’s opinion, now
that the CRA has endorsed these changes as clarifying in
nature, having both retroactive and prospective effect, it is
inappropriate for the CRA to remain silent on self-rectifica-
tion and contemporaneous documentation issues.
The jurisprudence is clear that legal form prevails in
Canadian transfer pricing cases. The Supreme Court of
Canada has on many occasions addressed the doctrine of
economic substance and significantly limited the CRA’s
ability to ignore the facts and circumstances, and substitute
economic fiction.
Two recent transfer pricing cases heard by the Tax Court
of Canada (TCC) also comment on the CRA’s discretion to
substitute legal reality with economic theory. In McKesson
(2013 TCC 404)), the TCC concluded that the CRA can
only recharacterise the legal reality under paragraph
247(2)(b), a special GAAR-like anti-avoidance rule in the
Canadian taxing statute. In the absence of a reassessment
under this recharacterisation provision, “[a] reassessment
under [paragraphs] 247(2)(a) and (c) does not permit a
recharacterisation of the transactions entered into by non-
arm’s length parties, nor can another different transaction
entirely be substituted therefore.” In Marzen (2014 TCC
194), the TCC agreed with the respondent’s reference to
the Current TP Guidelines in support of respecting legal
reality which states “[a] tax administration’s examination of
a controlled transaction ordinarily should be based on the
transaction actually undertaken by the associated enterprises
7
CANADA
as it has been structured by them.” Both these transfer pric-
ing cases are consistent with the earlier Supreme Court of
Canada decisions concerning the appropriate use of the doc-
trine of economic substance.
With Canada’s tax system having such a strong emphasis
on legal form, one might question how a Canadian court
would view a transfer pricing adjustment made by the CRA
to an R&D service contract as per example 17 above, once
CRA has chosen not to recharacterise any of the transac-
tions. That is, the OECD’s approach under its Amended
TP Guidelines is to reward the company that forms the
8 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
value creating function while ignoring the traditional entre-
preneurial principle of rewarding legal ownership with all or
at least a portion of residual profits. In other words, the
OECD seems to want to treat the company that contributes
to the value creation of the IP as the beneficial owner of the
IP in cases where they do not feel they have the grounds to
recharacterise the transaction. However, issues will arise in
the absence of further guidance on how to properly docu-
ment these transactions in those early years where no rev-
enues are generated. It will be interesting to see how these
cases will play out in a Canadian court.
SOUTH KOREA
There is more to BEPS than
meets the eye
Much lies beneath the
surface of BEPS. How
will BEPS affect Korean
multinationals and what
do MNEs need to
learn? Tae Hyung Kim,
partner and senior
transfer pricing
economist at Deloitte
Korea, explains exactly
what multinationals
must consider and what
they should fear.
10 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
he Korean National Tax Service (NTS) and the Ministry of Strategy
T and Finance are gearing up for what’s ahead with BEPS. They are
moving slowly but surely.
The ministry provides the specific guidance for master files and local
files. The details are stipulated in the Law for Coordination of
International Tax Affairs (LCITA) as Enforcement Decree (ED). The
guidance specifies who should submit what and when. In essence, what is
stipulated in the ED is literally the same as the Korean translation of
OECD Action 13 Annexes I and II. The LCITA-ED provides Korean tem-
plates for the master file (MF) and local file (LF). In both templates, the
ED itemises each information category and all specific items under each
category in Annexes I and II in Korean. Country-by-country reporting
requirements will be put in place certainly, not in fiscal 2016 but in fiscal
2017. That’s all that is planned so far for this year.
On the tax administration side, the NTS is moving rather quickly on the
resource side. The NTS acknowledges that sufficient resources are neces-
sary to perform risk assessments with the files and the information con-
tained in the files. The NTS plan to pool the right resources and train them
to perform risk assessments. Most of all, the author would like to see the
NTS bring in economics professionals to provide the necessary training to
the NTS examiners. The NTS has not recruited nor employed an econo-
mist since the inception of the LCITA in 1996, as far as the author is
aware.
Overall, the NTS and the ministry have been reactive in paying atten-
tion and responding to base erosion and profit shifting (BEPS). They have
followed developments at the OECD and monitored developments and
news in other jurisdictions around the globe, but until recently there has
not been much discussion between the government (both the NTS and the
ministry) and taxpayers. The practitioners have been rather active in com-
parison, holding public seminars to discuss and disseminate the OECD
final deliverables on actions.
In this article, the author intends to focus on what is below the surface
of BEPS. What does BEPS really mean to Korean MNEs? What do Korean
MNEs in particular need to think about? Why should the top management
care about BEPS? What’s next?
BEPS is a whole new ball game
There is little doubt that the tax authorities will have the upper hand with
important data and information at their fingertips. It was a different story

in the past. Under the new rules, the information required in
the master file (MF), local file (LF), and country-by-country
reports (CbCR) will cover almost every aspect of an MNE’s
business: global value chains and key profit drivers, a list of all
intangibles, the way the group is financed, transfer pricing
policies for major products, services, intangibles, and financial
arrangements, ties between the financial data used in transfer
pricing methods and the MNE’s financial statements, and so
on. The list goes on. The tax authorities can request even
more focused details on the information already supplied to
the extent that it is needed.
A few points are worth mentioning here. The objectives
are clear with transfer pricing documentation in Action 13.
What they really mean to MNEs is less clear. The focused and
specific information required under the MF and LF will be
handed over to the tax authorities before an audit. And the
exact same information will be available to all relevant tax
authorities at the same time.
The author would like to emphasise that a great deal of
focused and specific information will be in the hands of tax
authorities. What is clearly different with BEPS is that the
time frame for handing over all of this information to the tax
authorities will be before an audit. The availability of the
information to the tax authorities changes who’s calling the
shots in the ball game. Even before the ball game begins,
information will be fully analysed to assess risks for the audit.
MNEs should not miss the fact that tax authorities will have
plenty of time. Not a few weeks or months but even a few
years to the extent that the statute of limitation allows. Put
simply, it is enough time. Not to mention fast-changing data
analytics technology available everywhere. The information
can be sliced, diced, and drilled down on to the very bottom
of the issue quickly. This is new under the sun. Tax authorities
will try to put all available resources to full use before they pin
down the objects. In addition, MNEs should always remem-
ber that the exact same information will be available to virtu-
ally all relevant tax authorities at the same time. How will the
tax authorities in different jurisdictions respond? What can
MNEs do about it?
Prepare for unilateral actions
MNEs may wish that they had a crystal ball. It will not be easy
to predict the future. The author’s view is that the exact same
information is more likely to be interpreted differently by dif-
ferent tax authorities across continents. The differences could
be a result of various factors: different kinds of priorities and
interests, different ways of approaching issues and resolving
matters, different educational backgrounds, different levels of
experiences, different levels of understanding of the informa-
tion, and so on. As a result, they could view and respond dif-
ferently. All this could contribute to unilateral actions by each
tax authority. The author expects a significant number of
lengthy battles between tax authorities and MNEs and also
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
SOUTH KOREA
among competent authorities. In particular, MNEs should
keep this point in mind and take it into consideration when
they engage in disputes with the tax authorities.
Consistency should top the priority list
Inconsistency matters. MNEs need to pay particular attention
to transfer pricing methods and polices over the past years. Of
course, this is the case to the extent that the years fall within
the statute of limitation. The information contained in the
MF, LF, and CbCR can be analysed to assess risks in the past
years. If proper documentation is not in place for the past
years, the information provided in the MF, LF, and CbCR for
the fiscal year 2016 could provide benchmark information for
those years. The MNEs should expect that the tax authorities,
and in particular the NTS, can always confront the MNEs
with any inconsistency that exists between the past years and
the present year. It is worth double checking whether proper
transfer pricing policies were coordinated centrally by the
headquarters of the MNEs in the past.
Tax authorities lack and need proper training in
economics
A great deal of important information will be at the NTS’s
fingertips. The NTS will slice and dice the information to
make risk assessments and to determine whether an audit is
necessary. The author expects that tax authorities will contin-
ue to make investments in human resources. The resources
will be put in place to educate and train tax examiners and get
them ready before the rubber hits the road. The author
doubts, however, that the NTS will bring in economics pro-
fessionals to train them. That’s what might worry MNEs.
Most of the NTS examiners do not have the appropriate level
of capabilities needed in performing economic analysis. The
NTS does not have economists and lacks training in econom-
ics and therefore relevant skills. Value creation and profit allo-
cation is all about economics from the start and also at the
end of the day. Until the tax authorities are equipped with the
right analytical capabilities, it will pay off if the MNEs are
ready to go the extra miles to educate the tax authorities.
MNEs need to reset the mindset
MNEs vary in terms of the depth and breadth of experience,
understanding, and skills they have in BEPS-related issues and
matters. In other words, there are MNEs that fully under-
stand how BEPS will change the landscape of the global play-
ground and know what to do about it. There are MNEs that
do not have any idea about what it really means to them at all.
Advice and recommendations about what the MNEs need to
do should vary accordingly as well.
When cost concerns come first, it is hard to manage trans-
fer pricing policies. Getting the job done properly is a chal-
lenge. For example, to most Korean MNEs, and also for many
other non-Korean MNEs, minimising compliance costs tops
11
SOUTH KOREA
the priority list most of time. That mindset is more likely to
result in poorly prepared, low quality documentation. To
them, BEPS means just another cost or more costs. The
author’s view is that they fail to see the woods for the trees.
As a result, they don’t have a serious game plan.
The number one challenge, therefore, is to change the
mindset. Top management at the headquarters of MNEs
must understand BEPS in great detail and what it means to
them. They must know what MNEs need to do. MNEs are
required to disclose a lot of information that is sensitive and
confidential. For example, they need to describe the overall
R&D strategy including ownership and exploitation of intan-
gibles, location of principle R&D facilities, and location of
such management and provide a list of intangibles transferred
cross-border between related parties and a list of important
agreements, and so on. It is not a choice. It is a must.
To the author’s mind, the people at the top management of
most of the Korean MNEs need a wake-up call. Tax managers
and executives should make sure that the top management is
fully aware of what is required in BEPS. The level of detail for
the information that needs to be disclosed should be managed
properly in a professional manner. For that to happen, the top
management must understand the depth and breadth of the
details in the information required. Based on prudent business
judgment, the top management should be able to determine
the appropriate level of detail for the information that needs to
be disclosed. This is one of the most important processes in
preparing for BEPS challenges going forward.
Action 13 emphasises that the disclosed information will
be used only for tax risk assessment and audit purposes. Tax
administrations in all jurisdictions will do the job to protect
the confidentiality from their end. However; the level of legal
protection in each jurisdiction will vary depending on local
laws and enforcement efforts. It will be wise for MNEs to
make every effort to ensure that that remains the case. It is
prudent for MNEs to monitor such efforts being made
around the globe. Again, remember that all confidential infor-
mation will be accessed and analysed by virtually all relevant
tax authorities at the end of the day.
Time to move with a sense of urgency
There is a prevailing perception in Korea that what MNEs are
paying as taxes is not fair. Nowadays, this perception may
apply to other jurisdictions as well. Whenever there is news
about tax matters of MNEs, it is bad news. Bad news grabs
public attention quickly. It makes a big impact but in a bad
way. That is why Korean MNEs should worry about BEPS
12 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
Tae Hyung Kim
Partner & Economist
Deloitte Anjin LLC
Tel: +82 2 6676 2410
taehyungkim@deloitte.com
www.deloitteanjin.co.kr
Tae Hyung Kim is a senior partner and an economist at Deloitte
Korea. Kim has represented and advised multinational corporations
in various industries on their global transfer pricing and supply
chain management strategies for more than 19 years. In doing so,
he has handled and resolved complex transfer pricing disputes
and negotiations with both Korean and foreign tax authorities.
Kim has been recognised as a world leading transfer pricing
adviser by Euromoney’s Legal Media Group and also as a leader
in tax controversy in Korea by International Tax Review. As a
country panellist, he has been a regular contributor to BNA
Bloomberg’s international transfer pricing forum.
He holds a Ph.D. in economics from the University of
Washington and is also a graduate of the advanced manage-
ment programme of Harvard Business School. He graduated from
Korea University with BA in economics.
and pay attention immediately. The MNEs need to put in
place a strong team capable of handling all aspects of potential
risks from all angles. This requires new thinking about the
people with the right skill sets with global experiences.
It is no use locking the stable door after the horse has bolt-
ed. If BEPS is not managed properly, there will be the devil
to pay. Above all, it could do serious harm to brand and rep-
utation, not to mention operations and businesses. Social net-
works convey news in the wink of an eye. In particular, bad
news travels fast. It is a big deal.
A sense of urgency is needed. There are a few must-dos for
Korean MNEs. First and foremost, top management and
management executives should grasp the gravity of BEPS as
soon as possible. They also need to instill the sense of urgency
in employees to win their buy-in as well. Under the new rules
of the international tax game, noncompliance penalties, addi-
tional taxes, reputational risks, and loss of value-enhancing,
tax-saving opportunities won’t come in a small package.
Being wise after the fact is not wise after all.
SWITZERLAND
Intangibles in a post-BEPS
world
The framework for
analysing intercompany
transactions involving
intangibles is examined
by Hendrik
Blankenstein and
Caterina Colling Russo
at Tax Partner AG –
Taxand Switzerland.
Does the new DEMPE
analysis benefit MNEs
and tax authorities or
simply confuse matters,
resulting in an increase
of intangibles-related
disputes?
14 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
n October 5 2015, the OECD delivered a final package of reports
O providing recommendations and guidance in connection with the 15-
point action plan to address base erosion and profit shifting (BEPS).
The 186-page final report, which covers BEPS Actions 8-10,
Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10
Final Report (in this article referred to as the Report) offers guidance
on a multitude of transfer pricing topics, most importantly guidance for
applying the arm’s length principle (focusing on economic substance,
risks/control and corresponding rewards) and on intangibles.
The Report replaces various sections of the OECD Transfer Pricing
Guidelines for Multinational Enterprises and Tax Administrations, 2010
(TPG). For countries that formally subscribe to the TPG, the new guid-
ance offered by the Report takes the form of agreed amendments to the
TPG. These amendments will become part of the TPG after they have
formally been adopted by the OECD Council.
Within the Report a strong emphasis is placed on the accurate delin-
eation of the actual intercompany transaction by making use of pre-
determined analytical frameworks (para. 1.60, p. 22 and para. 6.34, p.
74) offering taxpayers and tax authorities a stepped approach on how to
achieve an accurate delineation of the transaction under review.
Paragraph 6.34 of the Report provides a specific analytical framework
for analysing intangibles in controlled transactions. Within the pre-
scribed analytical framework, multinational enterprises (MNE) need to
focus on the DEMPE functions (development, enhancement, mainte-
nance, protection and exploitation) with a view to determining which
group entities in the MNE undertake and more importantly control
these functions.
In this article, we will discuss the framework for analysing intercom-
pany transactions involving intangibles and, in particular, whether the
newly introduced DEMPE analysis benefits the MNEs and tax authori-
ties in their analysis or whether it will merely confuse matters resulting
instead in an increase of intangibles-related transfer pricing disputes.
Framework for analysing intercompany transactions involving
intangibles
The steps of the analytical framework will lead to a DEMPE analysis of
the transaction aimed at providing the MNE with all the ingredients to
correctly delineate the transaction before determining the intercompany
pricing.

Caterina Colling Russo
Tax Partner AG, Zurich
Tel: +41 44 215 77 56
caterina.collingrusso@taxpartner.ch
Caterina Colling Russo, a senior adviser with Tax Partner, has
more than 10 years’ full-time experience in transfer pricing con-
sulting. Caterina has previously held specialist transfer pricing
positions within global international tax and transfer pricing firms.
She has worked in Amsterdam, London and Rome.
Caterina has extensive experience in tax planning/restructuring
projects and has performed transfer pricing studies for clients in
a wide variety of industries including apparel, banking, luxury
goods, oil and gas, commodities, fast-moving consumer goods
and pharmaceutical. Caterina has provided assistance to clients
developing strategies for the conclusion of APAs as well as tax
audit defence in multiple European countries. Her technical skills
include valuation of intangibles, and transfer pricing aspects of
business restructuring. Moreover, she provides advice relating to
inter-company financial transactions, ranging from guarantee fee
and interest rate projects (transfer pricing policy and benchmark-
ing) to providing transfer pricing solutions for intermediate
finance companies as well as for captive insurance companies.
The framework for analysing transactions involving intan-
gibles between associated enterprises requires taking the fol-
lowing steps:
Step 1: Identify the intangibles
The MNE has to define the intangibles at stake with specifici-
ty, in conjunction with the specific, economically significant
risks associated with the DEMPE of the intangibles.
In order to support MNEs in performing this step, the
Report includes a definition of intangibles only for transfer
pricing purposes. Paragraph 6.6 defines intangibles as “some-
thing which is not a physical asset or a financial asset, which is
capable of being owned or controlled for use in commercial
activities, and whose use or transfer would be compensated
had it occurred between independent parties in comparable
circumstances”.
In addition, some guidance is given through examples of
what can and cannot be defined as intangibles. The examples
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
SWITZERLAND
Hendrik Blankenstein
Tax Partner AG, Zurich
Tel: +41 44 215 77 54
hendrik.blankenstein@taxpartner.ch
Hendrik Blankenstein is a partner of Tax Partner AG and leads its
transfer pricing team. From 1989 to 1995, Hendrik was an inter-
national tax consultant at Big 4 firms in both the US and the
Netherlands, from 1996-2004 he worked as an in-house interna-
tional tax and transfer pricing counsel at Nestlé’s HQ in
Switzerland, and from 2005 to 2015 as a Swiss based partner in
globally operating transfer pricing boutique consultancy firms.
Hendrik has been providing transfer pricing advice to Swiss
and foreign multinational clients in a variety of industries, cover-
ing design of transfer pricing systems, preparation of
masterfile/local file documentation, negotiation and conclusion of
unilateral/bilateral APAs, successful management of complex
transfer pricing audits and setting up transfer pricing risk man-
agement frameworks.
Tax Partner AG, which currently comprises 12 partners and 26
tax professionals, has become a leading Swiss tax boutique firm,
focusing on providing tax services such as international and
national corporate tax, individual tax and VAT. Each of the 12
partners has their area of specialisation. With regard to related
services such as legal, audit and accounting services, Tax Partner
typically cooperates with local firms. For further information
about Tax Partner, please refer to www.taxpartner.ch.
are, however, only for illustrative purposes and not intended
to be comprehensive. In this context, it is clarified that group
synergies and market-specific characteristics are elements to
take into account in a comparability analysis, but are not
intangibles.
Intangibles used or transferred in a controlled transac-
tion already under the existing guidelines needed to be
identified with some specificity. What is new is the DEMPE
analysis, i.e. the MNE has to identify which activities it clas-
sifies as development, enhancement, maintenance, protec-
tion and exploitation in relation to the defined intangible
and analyse the intercompany transactions focusing on
these activities.
Step 2: Identify the full contractual arrangement
It is recommended that the MNE maintains the documents
necessary to derive the legal basis of their cross-border inter-
company transactions involving intangibles, as these documents
15
SWITZERLAND
form the starting point for any transfer pricing analysis. The
terms of a transaction may be found in written contracts, public
records such as patent or trademark registrations, or in corre-
spondence and/or other communication among the parties. As
mentioned in the Report at para. 6.35, contracts may describe
the roles, responsibilities and rights of associated enterprises
with respect to intangibles.
Step 3: Identify the parties performing functions, using assets
and managing risks related to intangibles in relation to
DEMPE
The MNE has, by means of the functional analysis, to review
the conduct of the parties under a DEMPE analysis. In other
words, MNEs have to clarify which group entities:
• perform the DEMPE functions;
• use the assets related to the DEMPE functions; and
• control the economically significant risks related to the
DEMPE functions.
This analysis does not differ from the already well-known
and widely applied concept of functional analysis, however,
now from a DEMPE perspective. Therefore, MNEs are now
required to identify specific activities for each DEMPE func-
tion and ascertain the relative importance of each DEMPE
function. Such detailed analysis may be required not only
involving group entities, which are currently involved in
DEMPE activities, but also entities which performed
DEMPE activities in the past.
The Report fails to define the DEMPE functions in much
detail. It is clear that DEMPE may have a different meaning
depending on the industry. In pharma, the several stages of
R&D (and the importance of hard-to-value intangibles) may
assume great relevance whereas in consumer goods, the focus
may be more on brand value and the role of marketing and
advertising. However, even in the same industry, MNEs may
categorise activities – which are similar in nature – in a differ-
ent way.
Step 4: Review the consistency between contractual
arrangements and conduct of the parties through functional
analysis (DEMPE)
Once the contractual arrangements and the conduct of the
party/-ies have been reviewed within the DEMPE analysis
context, the MNE has to confirm that there is consistency
between legal and economic reality while determining
whether the party assuming economically significant risks aris-
ing out of the DEMPE functions also controls these risks and
has the financial capacity to assume them.
The conduct of the parties is leading. Only where the con-
duct of the parties and the legal reality of a transaction match
will a transfer pricing effect be produced: being the legal
owner of the intangible does not confer any right ultimately
to retain returns, even though such returns may initially
accrue to the legal owner as a result of legal rights.
16 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
The new guidance reaffirms and reinforces the necessity
for alignment between the legal reality and the economic real-
ity already present in the 2010 TPG and more importantly
the prevalence of the economic reality, i.e. the conduct of the
parties, over the legal reality (terms of the transaction). We
refer in particular to paragraph 1.48 of the 2010 TPG “in
relation to contractual terms, it may be considered whether a
purported allocation of risk is consistent with the economic
substance of the transaction. In this regard, the parties’ con-
duct should generally be taken as the best evidence concern-
ing the true allocation of risk.” Or paragraph 1.53 of the
2010 TPG: “The same divergence of interests may not exist
in the case of associated enterprises, and it is therefore impor-
tant to examine whether the conduct of the parties conforms
to the terms of the contract or whether the parties’ conduct
indicates that the contractual terms have not been followed or
are a sham. In such cases, further analysis is required to deter-
mine the true terms of the transaction.”
The DEMPE analysis should be considered when draft-
ing or reviewing intra-group agreements, specifically how
the allocation of roles, responsibilities and risks are provid-
ed for.
Step 5: Delineate the actual controlled transactions related to
the DEMPE of intangibles
This step is the key outcome of the analytical framework. In
this step, the MNE has, on the basis of the steps performed
so far, access to all the key elements to accurately delineate the
actual controlled transaction(s) related to the DEMPE of
intangibles, hence offering the required basis for determining
an arm’s length pricing of the delineated intercompany trans-
action (see next step).
Step 6: Pricing of the delineated transactions
The MNE, where possible, has to determine the arm’s length
prices for the transactions under review consistent with each
party’s contributions of functions performed, assets used and
risks assumed.
Assuming a BEPS-proof DEMPE analysis has been con-
ducted, a further and likely more far-reaching challenge will
be to determine the pricing of the delineated transaction con-
sistent with the respective contribution(s) of the group com-
panies to each of the DEMPE functions.
The Report addresses the extreme, however not rare, cases
of so-called “cash boxes”, in which an associated enterprise
provides funding without either performing any functions
relating to intangibles or control over the financial risk. For
these cases, the cash box would only be entitled to a risk-free
return, whereas in the presence of control over the financial
risk it can expect a risk-adjusted return on its funding.
More challenging however, and still lacking clear guid-
ance, are all those intercompany transactions where, often
for operational reasons, the DEMPE activities are highly
SWITZERLAND
fragmented amongst associated companies. The compensa-
tion for each party’s contribution might not be easy to
determine, especially in cases where the industry does not
offer good availability of comparable transactions undertak-
en by independent parties. The authors expect that cases like
these will probably lead to detailed price adjustment proce-
dures and probably in some more frequent cases to the
adoption of a profit split methodology.
Conclusions
In practice, the authors have observed that tax authorities have
started to require the taxpayer in tax audits, in litigation,
Advance Pricing Agreement (APA) and Mutual Agreement
Procedures (MAP) to substantiate their position using the
approaches laid down in BEPS Actions 8-10. Consequentially,
MNEs can expect having to demonstrate through the pre-
scribed frameworks, leading to a more detailed functional, risk
and DEMPE analysis, that the intercompany transactions are
delineated accurately and priced correctly.
Most steps in the framework for analysing intercompany
transactions involving intangibles are not new. What is new is
that – for intangibles-related transactions – MNEs need to focus
on the DEMPE functions with a view to determining who in the
MNE group undertakes and more importantly controls these
functions. Whilst the concept of identifying value-adding func-
tions and attributing returns based on the respective value added
is understood, the new OECD guidance fails to define the
DEMPE functions. The lack of definition of key terms of the
new guidance will undoubtedly lead to increased uncertainty as
the interpretation of a) which activities constitute which
DEMPE function and b) what relative importance should be
attributed to each function will likely lead to an increasing num-
ber of disputes between MNEs and tax authorities.
MNEs are required to ascertain the relative importance of
each DEMPE function in their respective industry and value
chain and identify specific activities for each DEMPE function in
order to be able to undertake the detailed analysis, as required.
18 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
MNEs’ burden of proof is expected to increase, and MNEs
should not miss the opportunity to explain the necessary
company and industry background underlying their transfer
pricing policies as part of their transfer pricing documenta-
tion. This includes a detailed description of the group supply
and value chain in the context of the intangibles-related trans-
actions. This is key to support the taxpayer in performing a
satisfactory DEMPE analysis.
In line with the refreshed concept of a transfer pricing mas-
ter file, as contained in Annex I to Chapter V of the Transfer
Pricing Documentation and Country-by-Country Reporting
– Action 13: Final Report – MNEs are now offered the
opportunity to present their supply chain as well as all the rel-
evant information needed to provide a blueprint of the group
and ultimately to support and justify the selected transfer pric-
ing policy.
Pricing intercompany transactions in light of a DEMPE
analysis in some industries will favour the use of a profit split
methodology, however guidance on profit split is still under
review within the BEPS project.
The DEMPE analysis will put some pressure on defining
the correct intercompany pricing and identifying comparable
uncontrolled prices, especially for those intercompany trans-
actions where, often for operational reasons, the DEMPE
activities are highly fragmented amongst associated compa-
nies. In these cases, would the taxpayer be able to find com-
parable independent parties that have allocated the DEMPE
functions in a comparable way? Again some industries will
offer good availability of comparable deals undertaken among
independent parties, where such comparables will not be
available, assuming the transaction has been correctly delin-
eated, this would certainly lead to detailed price adjustments
procedures and probably in some more frequent cases to the
adoption of a profit split methodology. Additional guidance
on the use of the profit split method, hopefully including
practical commercial examples for both businesses and tax
authorities, is expected to be provided by the OECD in 2017.

Responding to the changes in
the transfer pricing landscape
The Internal Revenue
Service appears to be
strengthening its stand
on aggregating
transactions and
applying economic
substance rationales to
override related-party
contracts. David Forst
and Larissa Neumann of
Fenwick & West discuss
US developments
including the IRS and
Treasury Department-
issued 482 Temporary
Regulations.
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
US
here have been a number of recent important developments on the
T US transfer pricing front. The Internal Revenue Service (IRS) issued
new § 482 regulations in what seems to be an effort to strengthen its
positions on aggregating transactions and applying economic substance
rationales to override related-party contracts.
In a recent Notice, the IRS stated that regulations will be issued apply-
ing the transfer pricing methods in the cost-sharing rules to transfers of
intangibles to controlled partnerships.
In the Guidant LLC v. Commissioner, 146 T.C. No. 5 (2016) motion
for partial summary judgment, the Tax Court ruled in favor of the IRS on
a question of aggregation in a transfer pricing adjustment.
New 482 Temporary Regulations
The Treasury Department and the IRS issued new Temporary Regulations
under § 482 that are effective to taxable years ending on or after
September 14 2015. The stated purpose is to coordinate § 482 with other
Code provisions. However, the changes to the 482 regulations appear to
be more aggressive than simple coordination rules and clarifying changes.
The preamble states that controlled transactions always remain subject
to Section 482 even if other Code provisions apply. In the preamble, the
IRS states that it has encountered taxpayer positions involving incomplete
assessments of the relevant functions, resources, and risks, and an inappro-
priately narrow analysis of the scope of the transfer pricing rules. It certain-
ly will benefit the taxpayer to have prepared thorough and well-drafted
documentation.
The new provision in Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(A) pro-
vides that arm’s length compensation must be consistent with, and must
account for all of, the value, without regard to the form or character of the
transaction. The regulation states it is necessary to consider the entire
arrangement as determined by the contractual terms, whether written or
imputed in accordance with the economic substance, in light of the actual
conduct of the parties. The IRS will likely attempt to use this regulation to
more aggressively assert that controlled parties’ contractual arrangements
should be ignored in favor of some broader economic substance argument.
Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(B) states that transactions may
be considered together, and taken as a whole, if they are so interrelated
that an aggregate analysis provides the most reliable measure of an arm’s
length result. Prior rules provided for aggregation only in the case of con-
trolled transactions involving related products or services. The preamble
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calls this a clarification, but the Obama administration pro-
posed a change in the statute to permit this type of aggrega-
tion, but that proposal was never enacted.
The Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(C) provision
provides that overall value (including any synergies) must be
taken into account. The preamble and regulations repeatedly
refer to “synergies”. It is not clear what these “synergies” are.
“Synergies” are not an intangible listed in § 936(h)(3)(B), and
parties operating at arm’s length do not license “synergies”.
The Temporary Regulation contains 11 examples.
Examples 1 through 4 are materially the same as prior regula-
tions. The remaining examples are new.
Example 5 deals with aggregation. Parent owns 10 individ-
ual patents that together can be used to manufacture and sell
a successful product. Parent anticipates that it can earn $25
from the patents as a bundle. Parent licenses all 10 patents to
a foreign subsidiary to be exploited as a bundle. Comparable
data indicates that each license is worth $1, implying a total
value of $10. The example states that it would not be appro-
priate to use the $1 dollar comparables because it does not
reasonably reflect the enhancement to value resulting from
the interrelatedness of the 10 patents exploited as a bundle.
In Example 6, parent and its foreign subsidiary have a cost
sharing agreement, but the parent continues to perform sup-
port for the foreign subsidiary. The example states that the
IRS may impute agreements or even another platform contri-
bution transaction (PCT) for the support services. This exam-
ple implies that the IRS’s assertion of economic substance
overrides the actual contractual terms. Examples 8 and 9 also
involve cost sharing agreements where the IRS can ignore the
contracts.
In Example 10, parent provides R&D services building on
the product platform. The example states the parent is provid-
ing an embedded value to the foreign subsidiary and the for-
eign subsidiary must compensate the US parent for this value.
The example states that parent takes the position that the
know-how does not have substantial value independent of the
services of any individual on the R&D Team. This is the posi-
tion the taxpayer took in Veritas and won.
Transfers of IP to Controlled Partnerships
In Notice 2015-54 Treasury and the Service state that they
intend to issue regulations similar to the Treas. Reg. § 1.482-
7 cost-sharing regulations to controlled transactions involving
partnerships. Specifically, the Notice states that regulations
will be issued applying the methods specified in Treas. Reg.
§ 1.482-7(g), as adjusted to take into account the differences
between partnerships and cost sharing arrangements.
Additionally, the Notice states that the regulations will pro-
vide periodic adjustment rules that are based on the principles
of Treas. Reg. § 1.482-7(i)(6) so that in the event of a trigger
based on a significant divergence of actual returns from pro-
jected returns, the IRS may make periodic adjustments under
20 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
a method based on Treas. Reg. § 1.482-7(i)(6)(v), as well as
any necessary corresponding adjustments to section 704(b) or
section 704(c) allocations.
The Notice states in its Reasons For Exercising Regulatory
Authority that an example it is concerned about is where a
domestic partner receives a fixed preferred interest in
exchange for the contribution of an intangible that is assigned
a value that is inappropriately low, while a related foreign
partner is specially allocated a greater share of the income
from the intangible.
The Notice appears to take the position that a taxpayer
who contributes intangible property and elects the Gain
Deferral Method, and therefore the application of the reme-
dial allocation method, could still be subject to further adjust-
ments in excess of its Built-in Gain amount. The Notice states
that when intangible property is contributed to a partnership,
the IRS may consider making periodic adjustments under
Treas. Reg. § 1.482-4(f)(2) in years subsequent to the contri-
bution, without regard to whether the taxable year of the
original transfer remains open for statute of limitations pur-
poses. It states that the IRS may do so regardless of whether
§ 721(a) applies to the initial contribution of intangible prop-
erty to the partnership. Therefore, in the IRS’s view, even if a
taxpayer elects the Gain Deferral Method, it still would be
subject to adjustments under § 482 even though § 721(a)
applies.
Of course, any new rules that the IRS writes in this regard
would need to be consistent with the arm’s length standard,
which underlies all of § 482. See, e.g., Treas. Reg. § 1.482-
1(b); Xilinx v. Commissioner, 598 F. 3d 1191 (9th Cir. 2010).
The Notice reiterates the application of § 482 to con-
trolled transactions involving partnerships under existing law.
See Treas. Reg. §§ 1.704-1(b)(1)(iii), -1(b)(5), Example 28
in this regard. The Notice states that examples of the applica-
tion of § 482 under current law include adjustments to the
amounts of contributions to, and distributions from, a part-
nership; partnership allocations, including allocations under
§ 704(c), and the relative magnitudes of the partners’ part-
nership interests in light of their respective contributions and
the related controlled transactions.
The Notice also states that the IRS can impute terms to a
partnership agreement that are consistent with the substance
of a transaction, for example, when a partner provides services
to the partnership but neither the partnership agreement nor
any other agreement reflects the provision of such services.
Further, according to the Notice, the IRS can apply an aggre-
gate analysis under Treas. Reg. § 1.482-1(f)(2)(i) to the
extent that controlled transactions involving a partnership,
including contributions of tangible and intangible property
and the provision of services by the controlled partners or
their affiliates, are interrelated if the aggregate analysis pro-
vides the most reliable means of determining the arm’s length
results for the controlled transactions.

David Forst
Fenwick & West
Tel: +1 650 335 7254
Fax: +1 650 938 5200
dforst@fenwick.com
www.fenwick.com
David Forst is the practice group leader of the tax group of
Fenwick & West. He is included in Euromoney’s Guide to the
World’s Leading Tax Advisers. He is also included in Law and
Business Research’s International Who’s Who of Corporate Tax
Lawyers (for the last six years). David was named one of the top
tax advisers in the western US by International Tax Review, is
listed in Chambers USA America’s Leading Lawyers for Business
(2011-2014), and has been named a Northern California Super
Lawyer in Tax by San Francisco Magazine.
David’s practice focuses on international corporate and part-
nership taxation. He is a lecturer at Stanford Law School on
international taxation. He is an editor of and regular contributor
to the Journal of Taxation, where his publications have included
articles on international joint ventures, international tax aspects
of M&A, the dual consolidated loss regulations, and foreign cur-
rency issues. He is a regular contributor to the Journal of
Passthrough Entities, where he writes a column on international
issues. David is a frequent chair and speaker at tax conferences,
including the NYU Tax Institute, the Tax Executives Institute, and
the International Fiscal Association.
David graduated with an AB, cum laude, Phi Beta Kappa, from
Princeton University’s Woodrow Wilson School of Public and
International Affairs, and received his JD, with distinction, from
Stanford Law School.
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
US
Larissa Neumann
Partner, Tax Group
Fenwick & West
Tel: +1 650 335 7253
lneumann@fenwick.com
www.fenwick.com
Larissa Neumann focuses her practice on US tax planning and tax
controversy with an emphasis on international transactions. She has
broad experience advising clients on acquisitions, restructurings and
transfer pricing issues. She has successfully represented clients in
federal tax controversies at the audit level, in appeals and in court.
Larissa appears in International Tax Review’s “World’s Tax
Controversy Leaders” and in Euromoney’s World’s Leading Tax
Advisers. Euromoney selected Larissa for inclusion in the Americas
Women in Business Law Awards shortlist for Best in Tax Dispute
Resolution in 2014 and she was named the 2015 Rising Star: Tax.
She was also named to the Silicon Valley Business Journal’s 40 Under
40. In 2016, Larissa was named a Rising Star in tax by Law360.
Larissa frequently speaks at conferences for professional tax
groups, including TEI, IFA, Pacific Rim Tax Institute, Bloomberg,
and the ABA. She is the ABA International Law Tax Liaison.
Larissa has published several articles, including recently:
• US Tax Overview, Euromoney’s LMG Rising Stars 2015
• US transfer pricing litigation update, International Tax Review
(March 2015)
• Areas of TP Scrutiny in a pre- and post-BEPS World,
International Tax Review (February 2015)
• U.S. International Tax Developments, The Euromoney Corporate
Tax Handbook 2015
• U.S. Transfer Pricing Developments, International Tax Review (2014)
• U.S. Tax Developments, International Tax Review
(December/January 2013)
• Character and Source of Income from Internet Business
Activities, The Contemporary Tax Journal (July 2011)
• The Application of the Branch Rule to Partnerships,
International Tax Journal (July – August 2010)
Fenwick has one of the World’s Top Tax Planning and Tax
Transactional Practices, according to International Tax Review, and is
first tier in tax, according to World Tax. International Tax Review gave
Fenwick its San Francisco Tax Firm Award a total of seven times and
its US Tax Litigation Firm Award a total of three times. International Tax
Review has also named Fenwick Americas M&A Tax Firm of the Year.
Larissa is a leader on Fenwick’s Pro Bono Review Committee
and regularly provides pro bono services to various nonprofit
organisations. Fenwick was recognised by The National Law
Journal Pro Bono Hot List (2014) and Larissa’s nonprofit work is
pointed to as exemplary in the profile.
21
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Finally, the Notice also states that Treasury and the IRS
are considering issuing regulations under Treas. Reg.
§ 1.6662-6(d) to require additional documentation for cer-
tain controlled transactions involving partnerships. These
regulations may require, for example, documentation of pro-
jected returns for property contributed to a partnership (as
well as attributable to related controlled transactions) and of
projected partnership allocations, including projected reme-
dial allocations covered, for a specified number of years.
Guidant
Guidant involves a group of US corporations that filed con-
solidated federal income tax returns (collectively, the “taxpay-
er”). During the years in issue, the taxpayer consummated
transactions with its foreign affiliates including the licensing
of intangibles, the purchase and sale of manufactured proper-
ty, and the provision of services.
The IRS utilised § 482 to adjust the reported prices of the
different transactions. The IRS asserted an adjustment to the
taxpayer’s income without making specific adjustments to any
of the subsidiaries’ separate taxable incomes. The IRS also did
not make specific adjustments for each separate transaction,
but rather asserted an aggregated transfer pricing adjustment.
The taxpayer filed a motion for partial summary judgment
asserting that the IRS adjustments were arbitrary, capricious,
and unreasonable as a matter of law since the IRS did not
determine “true taxable income” of each controlled taxpayer
as required under Treas. Reg. § 1.482-1(f)(iv) and did not
make specific adjustments with respect to each transaction.
The court denied the taxpayer’s motion stating that nei-
ther § 482 nor the regulations thereunder requires the IRS to
determine the true taxable income of each separate controlled
22 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
taxpayer within a consolidated group contemporaneously
with the making of a § 482 adjustment. The court also held
that the IRS is permitted to aggregate one or more related
transactions instead of making specific adjustments with
respect to each type of transaction.
While the court stated that Treas. Reg. § 1.482-1(f)(1)(iv)
requires the IRS to determine both consolidated taxable
income and separate taxable income when making a § 482
adjustment with respect to income reported on a consolidated
return, the court held that as a matter of law the IRS can
assert a § 482 adjustment before it determines the separate
taxable income. The court stated that the regulation does not
preclude the IRS from deferring making the separate taxable
income determinations for each member until the time when
such a determination is actually required.
The court stated that whether the IRS’s decision to delay
the separate-company taxable income computations consti-
tutes an abuse of discretion under these circumstances is still
in dispute and remains to be determined on the basis of the
full record as developed at trial. Thus, the court did not con-
clusively hold that the IRS’s § 482 adjustments were not arbi-
trary, capricious or unreasonable as a matter of fact. It only
held that the IRS’s § 482 adjustments were not arbitrary,
capricious, or unreasonable as a matter of law.
The taxpayer also argued that the IRS’s § 482 adjustments
were arbitrary, capricious and unreasonable because the serv-
ice did not make separate adjustments for each transfer of
intangible property, transfer of tangible property and provi-
sion of services. The applicable regulations in determining the
arm’s length consideration aggregation is permitted if it
serves as the most reliable means of determining the arm’s
length consideration for the transactions.