TRANSFER PRICING UPDATE: FINAL IRS REGULATIONS ON INTERCOMPANY SERVICES AND OECD PROPOSED REVISIONS TO THE TP GUIDELINES

1. WELCOME TO OUR WEBINAR TRANSFER PRICING UPDATE: FINAL IRS REGULATIONS ON INTERCOMPANY SERVICES AND OECD PROPOSED REVISIONS TO THE TP GUIDELINES Tuesday, October 6, 2009 | 1:00 p.m. EST If you cannot hear us speaking, please make sure you have called into the teleconference number on your invite information. • US participants: +1 800 734 8592 • Outside the US: +1 212 231 2905 The audio portion is available via conference call. It is not broadcast through your computer *This webinar is offered for informational purposes only, and the content should not be construed as legal advice on any matter.

2. Introduction of Speakers Eric D. Ryan Partner, Tax DLA Piper Contact Information: Phone: +1 650 833 2118 Fax: +1 310 687 1192 Mobile: +1 408 398 9912 E-mail Address: eric.ryan@dlapiper.com Office Address: 2000 University Avenue East Palo Alto, CA 94303-2248 United States Paul Flignor Principal Economist DLA Piper Contact Information: Phone: +1 312 984 5933 Fax: +1 312 630 5309 Mobile: +1 312 404 0437 E-mail Address: paul.flignor@dlapiper.com Office Address: 203 North LaSalle Street, Suite 1900Chicago, IL 60601-1293 United States Bernhard von Thaden Principal Economist DLA Piper Contact Information: Phone: +1 310 595 3147 Fax: +1 310 595 3447 Mobile: +1 310 869 3911 E-mail Address: bernhard.vonthaden@dlapiper.com Office Address: 1999 Avenue of the Stars, Fourth Floor Los Angeles, CA 90067-6022 United States Paul B. Burns Of Counsel, Tax DLA Piper Contact Information: Phone: +1 310 595 3002 Fax: +1 310 595 3302 Mobile: +1 714 423 7058 E-mail Address: paul.burns@dlapiper.com Office Address: 1999 Avenue of the Stars, Fourth Floor Los Angeles, CA 90067-6022 United States Transfer Pricing Update

3. Agenda • U.S. Intercompany Services Regulations • History and Introduction to Services Regulations • The Services Cost Method (SCM) • Allocations and Shared Service Arrangements • Intellectual Property and Intercompany Services • OECD Proposed Revisions To TP Guidelines • Support of Arm’s Length Standard • “Most Appropriate Method” • Use of Profit-based Methods • Comparability Issues Transfer Pricing Update

4. History - Transfer Pricing for Services • Prior 1968 Regulations §1.482-2(b)– Effective through 2006 • No specified TP methods • Integral / Non-Integral (four tests) regime for no mark-up • No mention of stock option compensation • 2003 Proposed Regulations §1.482-9 – Never effective • Temp. and Prop. Regulations §1.482-9T – Effective after 2006 • Specified TP methods • Services Cost Method for no mark-up • Stock options must be included in total services costs • 2009 Final Regs. §1.482-9 – Years starting after July 31, 2009 • Largely similar to 2006 Temp. and Prop. Regulations Transfer Pricing Update

5. Specified TP Methods for Services 1. Services Cost Method (SCM) 2. Comparable Uncontrolled Services Price Method (CUSP) 3. Gross Services Margin Method (GSM) 4. Cost of Services Plus Method (CSM) 5. Comparable Profits Method (CPM) 6. Profit Split Method (PSM) 7. Unspecified Methods Transfer Pricing Update

6. Services Cost Method (“SCM”) • SCM allocates costs without a mark-up. • The SCM is the taxpayer’s choice -- the IRS will not impose the SCM if the taxpayer prefers to employ a mark-up or other arm’s length approach. • Services must qualify as “covered services”- • Specified covered services – on a list provided by IRS (Announcement 2006-50 and Rev. Proc. 2007-13); OR • Low margin covered services – median markup is less than or equal to 7%; AND • Not an excluded category of high value services AND • Business Judgment Rule must be met • Taxpayer maintains documentation, including a statement evidencing the taxpayer’s intention to apply the SCM. Transfer Pricing Update

7. The Business Judgment Rule (“BJR”) • Taxpayer must reasonably conclude that services do not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of renderer, recipient, or both; • BJR is based on a taxpayer’s reasonable judgment. This may be challenged by the IRS. • The Final Regulations clarify that the BJR is based upon the consolidated business of the controlled group. Therefore, special purpose service entities may still qualify under the BJR for the SCM. • Selected examples: • Hospitals – one entity enters data into patient record system for the group;not a key competitive advantage • Data Entry Services - companies specialize in data processing;is a key competitive advantage • Manufacturer - legal departmentnot a key competitive item • Nuclear power plants - legal department’s ordinary activitiesnot a keycompetitive item, but activities with Nuclear Regulatory Commissionare key competitive items • The Final Regulations do not specify who at a taxpayer should apply the BJR, and do not specify how the conclusion should be documented. Obviously, a key item for Transfer Pricing Documentation. Transfer Pricing Update

8. Services Cost Method (“SCM”) - Comments • Comment:Rev. Proc. 2007-13 provides a list of 101 qualifying activities, which cover typical G&A type functions. Each major category of activities also includes “Other similar activities.” Therefore, it is likely taxpayers will take the position that all activities within most (if not all) G&A departments qualify for the SCM. • Best practice suggestion:Transfer pricing documentation should link individuals or departments with the appropriate item from the list of 101 activities. • Comment:Rev. Proc. 2007-13 does not cover sales or marketing activities. Marketing activities will likely qualify for the 7% or below median “low margin covered services” category, assuming an appropriate marketing comparables set is developed by the taxpayer. The IRS does not intend to maintain comparables sets for taxpayers. • Comment:The IRS may take the view that sales activities are an excluded category of high value services, and therefore do not qualify for the SCM. • Comment:Is there an inference that a taxpayer’s mark-up for excluded, high value service activities (e.g., R&D) should be more than 7%? • Comment:Stock option expense must be included in the cost base. Either GAAP 123R method or tax-based spread-at-exercise method may be used. Transfer Pricing Update

9. Final Regulations attempt to clarify definition of Stewardship • Activities that do not provide a benefit: • Activities that recipient would not be willing to pay to uncontrolled party because benefits are so indirect or remote • Activities that would duplicate an activity of the recipient, unless an additional benefit • Shareholder activities: if the sole effect of the activity is either to protect the renderer’s investment or facilitate compliance with regulatory requirements of renderer • Benefits from “passive association” (i.e., benefit results from the controlled taxpayer’s status as a member of the controlled group) • Twenty-one examples provided: • Sub has Legal Dept. and Parent’s Legal Dept. also reviews transaction documents;Sub has received a benefit since risks of transaction are reduced • Parent’s Internal Audit Dept. reviews Sub’s adherence to policies and US anti-bribery laws;activities are for Parent’s protection of investment and own compliance Transfer Pricing Update

10. Shared Service Arrangements (SSA) • The Final Regulations provide a mechanism for members of a multinational group to efficiently share the costs of services that are subject to the SCM and that benefit multiple members of the group. • Must include two or more participants. • Must include all controlled taxpayers that reasonably anticipate a benefit from one or more services specified in the arrangement. • Each covered service must confer a benefit on at least one participant. • Costs must be allocated based on reasonably anticipated benefit (“RAB” shares). • Taxpayer must maintain specified documentation. • Key benefit of an SSA: If taxpayer reasonably concluded that the SSA allocated costs on a basis that most reliably reflects RAB shares, IRS is precluded from forcing the taxpayer to use a different allocation key. Transfer Pricing Update

11. Allocating SSA Costs Based on RAB Shares • Costs must be allocated based on RAB shares even if the anticipated benefits do not materialize. • Allocation key selected must provide the most reliable measure of the participants’ RAB shares, under best-method-rule principles. • Final Regulations include several examples on selection of most reliable allocation key – such as headcount, revenues, transactions, etc. • Examples do not provide a bright line % variance, but instead show situations where allocation keys are reasonable / not reasonable. • If there are multiple types of services provided under an SSA, taxpayers should consider whether different allocation keys for different types of services are appropriate. • Allocation must be applied on a consistent basis for all participants and for all services. Transfer Pricing Update

12. Coordination of SSA, SCM, and CSAs • Services which do not qualify for the SCM can be included in an SSA without disqualification, per Notice 2007-5. However, “the flexible rules under the SCM for establishing the joint benefits and selecting the allocation key are inapplicable” to those services, according to the Final Regulations’ preamble. • If a participant in a SSA is also a participant in a CSA, any amount allocated to that participant under the SSA can be further allocated between the intangible development activity and other activities of the participant if it benefits both. • Any amount of a SSA allocation that is allocated to the intangible development activity would then be subject to being further carved up in accordance with the CSA’s method for allocating IDCs. Transfer Pricing Update

13. Intercompany Services and IP Closely Linked Alternative Arrangements Key Questions: • Nature of incremental benefits to IP? • How to value the contribution? ___ • IRS issued updated IP regs contemporaneously with the Service regs • Address issues related to services that support IP – either directly or indirectly • Establishes standards when a services arrangement will be respected and when a royalty structure will be asserted R&D Center(Country A) Contract R&D Svc(NCP) vs. License(Royalty) IP HoldCo(Country B) Transfer Pricing Update

14. Transfers of Intangible Property • §1.482-4(f)(3) • Ownership based on legal rights to IP applicable in relevant jurisdiction • If ‘economic substance’ of the transaction differs from legal rights, written intercompany agreement drives ownership question • If no written agreement, then controlled party who has ‘control’ of the IP will be considered sole owner • §1.482-4(f)(4) • A contribution that enhances the value of IP owned by another is subject to all the rules of 482 • If the contribution is embedded in the contractual terms, then no separate charge required • If the contribution is not covered by agreement, then all methods in 482 may be used to value the contribution,and a service charge may be re-characterized as a royalty Transfer Pricing Update

15. Transfer of Intangibles: Economic Substance • For the form of the transaction to be respected, the buyer must have ‘economic substance’ per §1.482-1(d)(3)(iii) • Sufficient means to control risk • Financial capacity to bear risk • Conduct consistent with risk bearing • Without sufficient substance the service charge can be disregarded or re-characterized as a royalty • Key Questions: • What functions lead to ‘control’?Strategic decision making • How many and what types of people?Management personnel • Does the risk have to be managed directly?Generally no Transfer Pricing Update

16. OECD TP Guidelines: Key Points • Maintains a strong endorsement of the Arm’s Length Standard as the primary international framework for transfer pricing • Endorses a ‘Most Appropriate Method” (“MAM”) standard similar to the U.S. “Best Method Rule” • Elevates profit-based methods (profit split, TNMM) to an equal level of transactional methods per the MAM • Portfolio of methods, similar to U.S. • Strongly rejects use of industry averages and broad, large comp sets • Endorses use of regional comp sets where insufficient local comps exist OECD has moved closer to the U.S. approach to transfer pricing Transfer Pricing Update

17. Support of the Arm’s Length Standard • Reaffirms strongly its support of the Arm’s Length Standard over ‘Formulary’ approaches • ALS is based on both the conditions that determine the controlled transaction and the profit that derives from the transfer price (§1.7) • Includes provision that the ALS is based on the options realistically available • Similar to U.S. regs, CSA, services, etc. • Some commentators have suggested this gives tax authorities the power to base adjustments on fictional transactions Transfer Pricing Update

18. Profit-based Methods Are Elevated, No Longer A ‘Last Resort’ • Previous OECD TPG listed profit based methods as a “last resort” • In Proposed, methods are in a hierarchy similar to the U.S. • Profit methods meet the Most Appropriate Method rule when: • Net margin more reliable than gross margin • Material differences in operating expenses • Unique intangibles owned by both parties => profit split • Limited external data on gross margins • This is still a transactional method – discourages use of company wide data Transfer Pricing Update

19. Transactional Profit Split • Appropriate when intangibles owned by both parties, significant integration economies, or lack of external data • General principles • Consistent functional analysis of both parties • Consistent derivation of combined profits and split factors • Consistent type (e.g., RPSM, global profit split, etc.) • Consistent over life of arrangement • Split factors based on: • Value of functions performed (~§1.482-6) • Other factors (cost, assets, etc.) • Financial accounts should be used • Rejects ‘BALRM’ equal returns for each party • Discourages use of hindsight to restate split factors Transfer Pricing Update

20. Transactional Net Margin Method • Still similar to U.S. CPM • TNMM requires a two-sided functional analysis • PLIs: Sales, costs, assets. Discourages use of Berry Ratio • May use standard costs instead of actual • For ROA, use or book or market value of assets may be used. • TNMM is still transactional – try to use as narrow a scope as possible rather than company-wide data Transfer Pricing Update

21. Comparability Issues • Regional comparable data sets are acceptable • Strong preference for narrower, smaller and more similar sets than large, broad data sets closer to transactional approaches • Most repeated statement in the Proposed Guidelines • Closer in principle to the transactional approach • Rejects use of industry averages for all comp sets • Endorses limited use of adjustments • No automatic adjustments (e.g., working capital) • Must justify each adjustment per MAM standard Transfer Pricing Update

22. Comparables Search Process • Deductive approach (“Top-Down”) • Start with broad set of SIC codes • Eliminate companies based on comparability criteria • Easy to replicate – dependent on access to tools • Additive approach (“Bottom-Up”) • Identify a list of subject company competitors • Eliminate per screening criteria • Tend to generate more comparable sets – more subjective All searches must be “Transparent, Systematic and Repeatable” Transfer Pricing Update

23. Conclusion Final Questions? Transfer Pricing Update