Financial Analysis and Pricing

							             Transfer pricing
                     Nerijus Nedzinskas
                      26 October 2005




*connectedthinking                        PwC
                Content
1.   Background
2.   Legislation
3.   Transfer pricing methods
4.   Transfer pricing documentation
5.   Main issues of transfer pricing
6.   PwC services


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               Background (1)
                       Globalization

    Increased cross border intercompany transactions

Manipulation of transfer prices in order to minimize the tax
                            burden

     Tax authorities forced to regulate transfer prices

                  Arm’s length principle

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               Background (2)
Arm’s length principle:

  The prices in intercompany transactions should not
  differ from the prices determined by unrelated parties
                           and
  the profit or income accrued from intercompany
  transactions should not differ from the profit or income
  earned from transactions between unrelated parties.


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                   Legislation (1)
•   The Law on Profit Tax (Art. 40):

    The Tax Authorities have the right to adjust the transaction
    prices if they do not conform to market prices.


•   The Order 1K-123 established by the Minister
    of Finance on 9 April 2004:

    Detailed regulation on transfer pricing prepared according
    to OECD recommendations: transfer pricing
    methods, documentation requirements, etc.
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                 Legislation (2)
• The Law on Profit Tax (Art. 2(8)):


  Associated parties – parties that meet one of the following
  criteria:
  • are related parties;
  • may influence each other and due to that the conditions of
  intercompany transactions may differ from those when each
  of the party maximizes its profit.




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               Legislation (3)
Tax Return Disclosure:

• The information about intercompany transactions
must be provided in the annual return, which must be
filed with the profit tax return from the financial year
started in 2005.

• The entities may not submit this annual return if the
total value of concluded transactions did not exceed
LTL 300,000 (~EUR 90,000) during financial year.


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  Transfer Pricing Methods (1)
When choosing the best transfer pricing method, the
available methods should be considered in the
following order:

 1. Comparable Uncontrolled Price (CUP);

 2. Resale Price or Cost Plus (C+);

 3. Profit Split or Transactional Net Margin (TNM).

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   Transfer Pricing Methods (2)
Type of Transaction              Possible method
Manufacturing of goods           CUP, C+, Profit split

Sale of goods                    CUP, Resale price,
                                 Profit split, TNM
Provision of services            CUP, C+, TNM

Financing (loans, deposits,      CUP, Profit split, TNM
guarantees)
Transfer of intangibles          CUP, C+
(technology, brand, know –how)

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Transfer pricing documentation (1)

 The transfer pricing documentation should
 be prepared by:
   1. Each tax payer whose turnover exceeds LTL 10
      million (~EUR 2,9 million) during the tax year before
      the controllable transaction takes place;
   2. Financial companies and credit institutions;
   3. Insurance companies.


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Transfer pricing documentation (2)
 The compulsory elements of transfer pricing
 documentation:
   •   Information about the parties involved in the transaction;
   •   Information about intercompany transactions:
       –    Characteristics of the subject of transaction;
       –    Functional analysis;
       –    Terms and conditions of the transaction;
       –    Economic circumstances of the transaction;
       –    Business strategy.
   •   Information about transfer pricing method used;
   •   Other information that reveals the important circumstances of
       transfer pricing.

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Transfer pricing documentation (3)
 Based on international experience, we structure the
 documentation as follows:
     1. Industry analysis: analyses of market trends, critical success
        factors;
     2. Company analysis: business overview and financial results of
        the parties involved in the transaction, description of their business
        strategy;
     3. Functional analysis: description of functions performed, risk
        assumed and assets engaged by related parties;
     4. Description of intercompany transactions: characteristics of
        the subject of transaction, analysis of costs borne by related parties;
        determination of benefits derived from intercompany transactions;
     5. Economic analysis: description of the pricing methodology,
        selection of transfer pricing method, benchmarking study, financial
        analysis.
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         Main issues (1)

1. The accessibility of information;
2. Comparability of transactions;
3. Management services;
4. Transfers of intangibles.




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              Main issues (2)
Accessibility of information:
•   Public available information is limited;

•   Some information may be not reliable;

•   The access to the commercial data bases is fairly expensive;

•   Third parties often are not willing to reveal the information.




Complications determining the arm’s length range and justifying
                      the transfer prices.


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                Main issues (3)
Comparability of transactions:
Application of arm’s length principle involves a comparison of the terms
and conditions in a controlled transaction between related parties with the
terms and conditions in transactions between independent parties.


The degree of comparability depends on various factors: characteristics of
goods, property or services, contractual terms, economical circumstances,
functions performed, risk assumed, business strategies, etc.




        Difficulties to find highly comparable transactions.


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               Main issues (4)
Management services:
•   Service agreements lack information on service specification,
    costs arising in the parent company and calculation of the
    charge (fee) for service rendered.
•   The costs of parent company (“shareholder’s costs”) are
    transferred to its subsidiaries.
•   Duplication of services.
•   Mark-up is too high or not added at all.



        The fee for management services is not justified.

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                 Main issues (5)
Transfers of intangibles:
•     There is generally not an active market for intangibles.
•     Transactions involving intangibles often include other assets
      and liabilities, disguising the value of the subject of intangible.

•     Transaction prices are often not disclosed.




    Limited comparability and complications determining the arm’s
                              length range.


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      Main issues (6)
 The main issue – the Lithuanian Tax
   Authorities have not yet started
reviewing intercompany transactions




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            PwC services

1. Review of intercompany transactions and
   comments on transfer pricing policy;
2. Preparation of transfer pricing documentation;
3. Preparation of benchmarking study in order to
   determine the arm’s length range;
4. Review and amendment of transfer pricing
   documentation prepared by a company.


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                  Contacts
•   Kristina Kriščiūnaitė-Bartusevičienė
    Head of Tax Services
    Tel. (8-5) 239 23 65
    kristina.bartuseviciene@lt.pwc.com

•   Nerijus Nedzinskas
    Senior Consultant
    Tel. (8-5) 239 23 50
    nerijus.nedzinskas@lt.pwc.com


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