Category: Annex to Chapter VIII – Examples on CSA/CCA

Examples to Illustrate the Guidance on Cost Contribution Arrangements

Chapter VIII Annex example 1

Example 1 illustrates the general principle that contributions should be assessed at value (i.e. based on arm’s length prices) in order to produce results that are consistent with the arm’s length Company A and Company B are members of an MNE group and decide to enter into a CCA. Company A performs Service 1 and Company B performs Service 2. Company A and Company B each “consume” both services (that is, Company A receives a benefit from Service 2 performed by Company B, and Company B receives a benefit from Service 1 performed by Company A). Assume that the costs and value of the services are as follows: Costs of providing Service 1 (cost incurred by Company A) 100 per unit. Value of Service 1 (i.e. the arm’s length price that Company A would charge Company B for the provision of Service 1) 120 per unit. Costs of providing Service 2 (cost incurred by Company B) 100 per unit. Value of Service 2 (i.e. the arm’s length price that Company B would charge Company A for the provision of Service 2) 105 per unit In Year 1 and in subsequent years, Company A provides 30 units of Service 1 to the group and Company B provides 20 units of Service 2 to the group. Under the CCA, the calculation of costs and benefits are as follows: Cost to Company A of providing services (30 units * 100 per unit) 3 000 (60% of total costs) Cost to Company B of providing services (20 units * 100 per unit) 2 000 (40% of total costs) Total cost to group 5 000 Value of contribution made by Company A (30 units * 120 per unit) 3 600 (63% of total contributions) Value of contribution made by Company B (20 units * 105 per unit) 2 100 (37% of total contributions) Total value of contributions made under the CCA 5 700 Company A and Company B each consume 15 units of Service 1 and 10 units of Service 2: Benefit to Company A: Benefit to Company B Service 1: 15 units * 120 per unit 1 800 Service 2: 10 units * 105 per unit 1 050 Total 2 850 (50% of total value of 5 700) Service 1: 15 units * 120 per unit 1 800 Service 2: 10 units * 105 per unit 1 050 Total 2 850 (50% of total value of 5 700) Under the CCA, the value of Company A and Company B’s contributions should each correspond to their respective proportionate shares of expected benefits, i.e. 50%. Since the total value of contributions under the CCA is 5 700, this means each party must contribute 2 850. The value of Company A’s in-kind contribution is 3 600 and the value of Company B’s in-kind contribution is 2 100. Accordingly, Company B should make a balancing payment to Company A of 750. This has the effect of “topping up” Company B’s contribution to 2 850; and offsets Company A’s contribution to the same amount. If contributions were measured at cost instead of at value, since Companies A and B each receive 50% of the total benefits, they would have been required contribute 50% of the total costs, or 2 500 each, i.e. Company B would have been required to make a 500 (instead of 750) balancing payment to A. In the absence of the CCA, Company A would purchase 10 units of Service 2 for the arm’s length price of 1 050 and Company B would purchase 15 units of Service 1 for the arm’s length price of 1 800. The net result would be a payment of 750 from Company B to Company A. As can be shown from the above, this arm’s length result is only achieved in respect of the CCA when contributions are measured at

Chapter VIII Annex example 1a

8. The facts are the same as Example 1. In accordance with the guidance in paragraph 8.27, an alternative way to achieve the identical result under Example 1 is through the use of a two-step process as set out below 9. Step 1 (contributions measured at cost): Company A should bear 50% of the total cost of 5 000, or 2 500. The cost of Company A’s in-kind contribution is 3 000. Company B should bear 50% of the total cost, or 2 500. The cost of Company B’s in-kind contribution is 2 000. Company B should thus make an additional payment to Company A of 500. This reflects a balancing payment associated with current contributions 10. Step 2 (accounting for additional contributions of value to the CCA): Company A produces 20 of value above costs per unit. Company B produces 5 of value above costs per unit. Company A consumes 10 units of Service 2 (50 of value over cost), and Company B consumes 15 units of Service 1 (300 of value over cost). Accordingly, Company A should be compensated 250 for the additional 250 of value that it contributes to the CCA. This reflects a balancing payment associated with pre-existing contributions. 11. The two-step method provides for a sharing of costs plus a separate and additional payment to the participant that makes an additional contribution of value to the arrangement. In general, the additional contribution of value might reflect pre-existing contributions, such as intangibles owned by one of the participants, that are relevant to the purpose of the CCA. Thus, the two-step method might be most usefully applied to development CCA’s

Chapter VIII Annex example 2

Example 2 12. The facts are the same as Example 1, except that the per-unit value of Service 1 is 103 (that is, both Service 1 and Service 2 are low-value services). Assume, therefore, that the calculation of the costs and value of the services is as follows: Cost to Company A of providing services (30 units * 100 per unit) 3 000 (60% of total costs) Cost to Company B of providing services (20 units * 100 per unit) 2 000 (40% of total costs Total cost to group 5 000 Value of contribution made by Company A (30 units * 103 per unit) 3 090 (59.5%     of     total contributions) Value of contribution made by Company B (20 units * 105 per unit) 2 100 (40.5%     of     total contributions) Total value of contributions made under the CCA 5 190 Company A and Company B each consume 15 units of Service 1 and 10 units of Service 2: Benefit to Company A: Benefit to Company B Service 1: 15 units * 103 per unit 1 545 Service 2: 10 units * 105 per unit 1 050 Total 2 595 (50% of total value of 5 190) Service 1: 15 units * 103 per unit 1 545 Service 2: 10 units * 105 per unit 1 050 Total 2 595 (50% of total value of 5 190) 13. Under the CCA, the value of Company A and Company B’s contributions should each correspond to their respective proportionate shares of expected benefits, i.e. 50%. Since the total value of contributions under the CCA is 5 190, this means each party must contribute 2 595. The value of Company A’s in-kind contribution is 3 090. The value of Company B’s in- kind contribution is 2 100. Accordingly, Company B should make a balancing payment to Company A of 495. This has the effect of “topping up” Company B’s contribution to 2 595; and offsets Company A’s contribution to the same 14. In this example, since all contributions to the CCA are low-value services, for practical reasons, contributions may be valued at cost since this will achieve results which are broadly consistent with the arm’s length principle. Under this practical approach, the cost of Company A’s in-kind contribution is 3 000; the cost of Company B’s in-kind contribution is 2 000; and each participant should bear the costs associated with 50% of the total cost of contributions (2 500). Accordingly, Company B should make a balancing payment to Company A of 500.
Chapter VIII Annex example 3

Chapter VIII Annex example 3

15. The facts are the same as Example 1, except that the per-unit value of Service 2 is 120 (that is, both Service 1 and Service 2 are equally valuable, and neither are low-value services). 16.          Under the CCA, the value of Company A and Company B’s contributions should each correspond to their respective proportionate shares of expected benefits i.e. 50%. Since the total value of contributions under the CCA is 6 000, this means each party must contribute 3 000. The value of Company A’s in-kind contribution is 3 600. The value of Company B’s in- kind contribution is 2 400. Accordingly, Company B should make a balancing payment to Company A of 600. This has the effect of “topping up” Company B’s contribution to 3 000; and offsets Company A’s contribution to the same amount. Example 3 illustrates that, in general, assessing contributions at cost will not result in an arm’s length outcome even in those situations in which the arm’s length mark-up on the cost of contributions is identical.

Chapter VIII Annex example 4

Company A and Company B are members of an MNE group and decide to undertake the development of an intangible through a CCA. The intangible is anticipated to be highly profitable based on Company B’s existing intangibles, its track record and its experienced research and development staff. Company A performs, through its own personnel, all the functions expected of a participant in a development CCA obtaining an independent right to exploit the resulting intangible, including functions required to exercise control over the risks it contractually assumes in accordance with the principles outlined in paragraphs 8.14 to 8.18. The particular intangible in this example is expected to take five years to develop before possible commercial exploitation and if successful, is anticipated to have value for ten years after initial Exploitation. Under the CCA, Company A will contribute to funding associated with the development of the intangible (its share of the development costs are anticipated to be USD 100 million per year for five years). Company B will contribute the development rights associated with its existing intangibles, to which Company A is granted rights under the CCA irrespective of the outcome of the CCA’s objectives, and will perform all activities related to the development, maintenance, and exploitation of the intangible. The value of Company B’s contributions (encompassing the performance of activities as well as the use of the pre-existing intangibles) would need to be determined in accordance with the guidance in Chapter VI and would likely be based on the anticipated value of the intangible expected to be produced under the CCA, less the value of the funding contribution by Company A. Once developed, the intangible is anticipated to result in global profits of USD 550 million per year (Years 6 to 15). The CCA provides that Company B will have exclusive rights to exploit the resulting intangible in country B (anticipated to result in profits of USD 220 million per year in Years 6 to 15) and Company A will have exclusive rights to exploit the intangible in the rest of the  world  (anticipated  to  result  in  profits  of  USD 330 million per year). Taking into account the realistic alternatives of Company A and Company B it is determined that the value of Company A’s contribution is equivalent to a risk-adjusted return on its R&D funding commitment. Assume that this is determined to be USD 110 million per year (for Years 6 to 15).1 However, under the CCA Company A is anticipated to reap benefits amounting to USD 330 million of profits per year in Years 6 to 15 (rather than USD 110 million). This additional anticipated value in the rights Company A obtains (that is, the anticipated value above and beyond the value of Company A’s funding investment) reflects the contribution of Company B’s pre-existing contributions of intangibles and R&D commitment to the CCA. Company A needs to pay for this additional value it receives. Accordingly, balancing payments from Company A to  Company B to account for the difference are required. In effect, Company A would need to make a balancing payment associated with those contributions to Company B equal in present value, taking into account the risk associated with this future income, to USD 220 million per year anticipated in Years 6 to 15.

Chapter VIII Annex example 5

21. The facts are the same as in Example 4 except that the functional analysis indicates Company A has no capacity to make decisions to take on or decline the risk-bearing opportunity represented by its participation in the CCA, or to make decisions on whether and how to respond to the risks associated with the opportunity. It also has no capability to mitigate the risks or to assess and make decisions relating to the risk mitigation activities of another party conducted on its behalf. 22. In accurately delineating the transactions associated with the CCA, the functional analysis therefore indicates that Company A does not control its specific risks under the CCA in accordance with the guidance in paragraph 8.15 and consequently is not entitled to a share in the output that is the objective of the CCA.