EUROPEAN AEROSPACE SYSTEMS Plc

EUROPEAN AEROSPACE SYSTEMS plc

AGN INTERNATIONAL – ITC Session– Case Study

1. Introduction

This case study based on the UK based European Aerospace Systems ("EAS") has a number of multiple examples of intercompany pricing issues that could exist within today’s increasingly complex multinational companies. This case study looks at these transfer pricing-related issues that the participants should consider identifying these issues and how best to address them. While all intercompany pricing arrangements are unique, a look at EAS’s history and trading pattern can offer valuable insights that could be applied to other companies in similar situations.

1. Definitions

EASBrazil - European Aerospace Systems do Brasil Limitada

EAS UK - the UK parent company

EAS Cayman - European Aerospace Systems Cayman Island Corp

EAS China - European Aerospace Systems China Ltd

EAS France - European Aerospace France SARL

EAS - The worldwide group

IDC - Intangibles Development Cost

IPR - Intellectual Property Rights

Pacific US - Pacific Air Services Company headquartered in USA

Spectrum - Spectrum Aerosystems Corporation

Aircraft wings- components for aircraft wings

1. Beginnings

At the advent of World War II, Farnborough, England was the centre of the aerospace industry. Several aerospace companies flourished in the Farnborough area. In 1938, European Aerospace Systems ("EAS”) will hereafter refer to the worldwide group, and “EAS UK ” will refer to the UK parent company)was founded in an aircraft hangar next to the future site of Farnborough Airport. The team of aerospace engineers at EAS UK developed and produced some of the first engineering parts that would prove to be a critical part of aircraft wings especially for military aircraft. .

From the 1960s through the 1990s, EAS witnessed massive growth and established manufacturing locations in numerous parts of the UK. EAS went public in 1991, with shares traded on the London Stock Exchange under the ticker symbol EAS.

1. Global Growth

In the mid 2000s, the directors of EAS UK determined that EAS needed to expand internationally in order to grow its customer base and capitalise on lower labour costs.

The first step in EAS’s international expansion came in 2006, when EAS established European Aerospace China Ltd. (EAS China), a Chinese subsidiary that is a wholly foreign-owned enterprise (WFOE) operating a manufacturing plant in Suzhou, China. Production of two of EAS's aircraft wings was moved to EAS China’s Suzhou plant in early 2007. EAS China gained expertise on how to manufacture aircraft wings from 25 EASUK's personnel sent to China throughout 2006. EAS UK also transferred to EAS China the production equipment previously used at its former manufacturing plant in Farnborough, England. EAS China sells the wings it manufactures to various EAS foreign affiliates, notably EAS UK, and to EAS China’s own customers in China. Given China’s growing aerospace industry EAS China also purchases other variations of the wings from EAS UK Farnborough plant for resale to third-party aerospace companies in China.

After EAS UK sales personnel won a large contract with Airbus (EADS) in 2007, EAS established a French subsidiary – European Aerospace France SARL (EAS France) – in Toulouse, France. EAS France purchases aircraft wings from EAS UK’s Farnborough plant and from EAS China’s Suzhou plant and resells them to Airbus for use in production of its commercial airplanes. For the financial year ended December 31, 2012, EASF earned a pre-tax operating margin of 25.4 percent on its purchase and resale of aircraft wings purchased from EAS UK and EAS China.

In 2007, EAS acquired Pacific Air Services Company, based in Fightertown, USA. Pacific US has contracts with airlines around the world to service aircraft wings. Aircraft wings require mandatory servicing for every 250,000 miles flown. The process of servicing and fixing aircraft wings is complex; requiring technicians to undergo significant training and use unique tools and processes developed by Pacific US. Pacific US has subsidiaries in the United Kingdom, France, Spain, Belgium, Ireland, Hungary, the Netherlands, Switzerland, Germany, South Africa, Canada, Brazil, Argentina, Mexico, Japan, China and Australia. Post-acquisition, Pacific US continues to serve as the Pacific US division’s headquarters. While all historical service know-how, processes and tools were developed at Pacific US’ Fightertown headquarters, Pacific US has built a service database on how to service aircraft wings; all of the Pacific US's subsidiaries now contribute their experience to the database. Aircraft wing servicing is highly profitable, and the Pacific US division accounts for 35 percent of EAS’s gross profits but only 15 percent of its revenues.

In 2008, EAS UK purchased the aircraft wing software division from defence giant Spectrum AerosystemsCorporation, a company headquartered in Boston, Massachusetts. Spectruml's software operates the aircraft wings. A year later, EAS’s in-house tax department established a Cayman Islands corporation (EAS Cayman) to engage in a research and development cost-sharing arrangement with EAS UK. Under the terms of the cost-sharing arrangement, EAS UK owns intellectual property rights (IPR) for the UK market and EAS Cayman owns the IPR for the rest of the world. EAS’s tax department determined EAS Cayman did not need to make a buy-in payment (or platform contribution transaction), given that a third-party valuation firm’s valuation report covering the purchase price allocation did not attribute any value to the pre-existing intellectual property.

In late 2009, EAS UK established European Aerospace do BrasilLimitada (EAS Brazil, a wholly owned subsidiary in Brazil) to sell aircraft wings to Aerotec Bravo, a big Brazilian aircraft manufacturer.EAS UK sells the aircraft wings directly to Aerotec Bravo, while EAS Brazil provides customer service to Aerotec Bravo. EAS Brazil has not recorded any profits to date.

EAS UK also recently established subsidiaries in Zurich, Switzerland, and Singapore, which will serve as the European and Asian headquarters and are responsible for overseeing the subsidiaries and growing revenues in their respective regions. Several senior-level executives were transferred from EAS UK to the Swiss and Singaporean entities.

1. EAS International Issues

EAS Tax Director Pat Collins attended a recent meeting of EAS’s financial statement audit committee, where he learned from EAS’s financial statement auditors that EAS’s transfer pricing-related issues are no longer immaterial to the group’s consolidated financial statements. The auditors plan to examine transfer pricing-related issues analysis during their next audit. This announcement has Mr. Collins worried, because EAS has not undertaken any formal transfer pricing studies and EAS’s affiliates in the U.S., Brazil, China and France have received notice of impending tax audits.

CASE STUDY ANALYSIS REQUIRED

This case study should be considered from two aspects:

1 The local tax authorities of each country in which each company operates in looking at where transactions do not appear to be at arm’s length and are vulnerable to an enquiry by the tax authorities.

2 The tax advisers acting for each company in their respective jurisdiction looking at what opportunities for planning exist which would enable the group overall tax rate to be reduced.

Each participant in the seminar will be allocated to groups with each group having a leader who should be responsible for directing the group on the transfer pricing issues and subsequently providing a report on the discussions.

The questions that each group need to tackle are as follows:

Tax Authorities (especially from the experiences within your respective country)

1. Identify all related-party transaction flows, e.g., services, transfers of tangible property, transfers of intangible property, etc.

2. What questions would you ask during a functional analysis, i.e., fact-finding, meeting?

3. What existing intercompany transactions would you challenge as they do not appear to conform to the arm’s-length standard?

a. From what side, i.e. which jurisdiction?

b. Why?

4. What additional intercompany transactions would you impose?

a. From what side, i.e. which jurisdiction?

b. Why?

Tax Advisors (especially from the experience within your respective country)

1. Identify all related-party transaction flows, e.g., services, transfers of tangible property, transfers of intangible property, etc.

2. What questions would you ask during a functional analysis meeting?

3. What transfer pricing-related opportunities would you bring up to Mr. Collins from a planning and operational standpoint?

4. What transfer pricing-related threats would you bring up to Mr. Collins from an audit and operational standpoint?

5. How would you approach the topic of transfer pricing documentation with Mr. Collins?

The Appendices provide further background to the EAS group history ( Appendix 1) and also the financial statistics for the group (Appendix 2).

APPENDIX 1

Aerospace industry in the United Kingdom

The aerospace industry of the United Kingdom is the second- or third-largest national aerospace industry in the world, depending upon the method of measurement. The industry employs around 113,000 people directly and around 276,000 indirectly and has an annual turnover of around £20 billion.

Current manned aircraft in which the British aerospace industry has a major role include the AgustaWestland AW101, AgustaWestland AW159, Airbus A320 family, Airbus A330, Airbus A340, Airbus A380, Airbus A400M, BAE Hawk, Boeing 767, Boeing 777, Boeing 787, Bombardier CRJ700, Bombardier CSeries, Bombardier Learjet 85, Britten-Norman Defender, Britten-Norman Islander, Eurofighter Typhoon, Hawker 800, Lockheed Martin C-130J Super Hercules and Lockheed Martin F-35 Lightning II. Current unmanned aerial vehicles in which the British aerospace industry has a major role include the European Aerospace Systems'sTaranis, Barnard Microsystems InView Unmanned Aircraft System, QinetiQ Zephyr and Watchkeeper WK450.

The British aerospace industry has made many important contributions to the history of aircraft, and was solely or jointly responsible for the development and production of the first aircraft with an enclosed cabin (the Avro Type F), the first jet aircraft to enter service for the Allies in the Second World War (the Gloster Meteor), the first commercial jet airliner to enter service (the de Havilland Comet), the first aircraft capable of supercruise (the English Electric Lightning), the first supersonic commercial jet airliner to enter service (the Aérospatiale-BAC Concorde), the first fixed-wing V/STOL combat aircraft to enter service (the Hawker Siddeley Harrier),] the first twin-enginedwidebody commercial jet airliner (the Airbus A300), the first fly-by-wire commercial aircraft (the Airbus A320) and the largest commercial aircraft to enter service to date (the Airbus A380).

Current major participants

AgustaWestland

AgustaWestland is an international helicopter manufacturer owned by Finmeccanica of Italy. In the United Kingdom, the company has one factory in Yeovil, employing more than 4,000 people. Its main products with a large British content are the EH101, the Super and Future Lynx and the AW139 and AW149.

Airbus UK

An Airbus A380, the wings and engines of which are produced in the UK.

Airbus (a subsidiary of EADS) directly employs around 13,000 people at its UK division Airbus UK, with estimates that it supports another 140,000 jobs in the wider UK economy. The traditional UK workshare in Airbus aircraft is around 20%. Airbus has major sites at Filton in the city of Bristol and at Broughton in north Wales. Filton is the main research and development and support centre for all Airbus wings, fuel systems and landing gear integration. Broughton, which employs over 5,000 people, is the main wing manufacturing centre for all Airbus aircraft and also builds the fuselage and wings of the Hawker 800. Since 2006 Airbus has also had a small development centre in the Midlands.

Astrium (a subsidiary of EADS) is the largest space company in Europe and employs around 2,700 people in the UK. It has sites at Stevenage (1,200 employees), Portsmouth (1,400 employees) and Poynton (120 employees).

European Aerospace Systems

European Aerospace Systems campus in Farnborough, United Kingdom

The UK-headquartered European Aerospace Systems is the world's second-largest defence contractor and it employs around 36,400 people in the UK. The largest aerospace related locations of European Aerospace Systems are Warton, Samlesbury, Brough and Woodford. The final assembly line for the British Eurofighter Typhoons, a collaborative European programme, is located at Warton. All flight test activity for manned aircraft is undertaken from Warton, which is also the development centre within European Aerospace Systems, for unmanned aerial vehicles (UAVs), UCAVs and the Saudi Tornado upgrade programme. Samlesbury is the production hub of the Military Air Solutions division of BAE Systems. Here, components for the Eurofighter Typhoon, the F35 Lightning II, the Hawk, UAVs, UCAVs and Airbus aircraft get built. At Brough, the EAS Hawk gets produced and finalassembled, flight tests are done at Warton. Overall, Military Air Solution has 14,000 employees spread across eight sites in the United Kingdom.

European Aerospace Systems plc is a British multinationaldefence, security and aerospace company headquartered in London, United Kingdom and with operations worldwide. It is among the world's largest defence contractors; it ranked as the third-largest based on applicable 2011 revenues. Its largest operations are in the United Kingdom and United States, where its subsidiary is one of the six largest suppliers to the US Department of Defense. Other major markets include Australia, India and Saudi Arabia. EAS was formed on 30 November 1999 by the £7.7billion merger of two British companies; Marconi Electronic Systems (MES) - the defence electronics and naval shipbuilding subsidiary of the General Electric Company plc (GEC) - and European Aerospace (EA) - an aircraft, munitions and naval systems manufacturer.

European Aerospace Systems is the successor to various aircraft, shipbuilding, armoured vehicle, armaments and defence electronics companies, including The Marconi Company, the first commercial company devoted to the development and use of radio; A.V. Roe and Company, one of the world's first aircraft companies; de Havilland, manufacturer of the world's first commercial jet airliner; British Aircraft Corporation, co-manufacturer of the Concorde supersonic transport; Supermarine, manufacturer of the Spitfire; Yarrow Shipbuilders, builders of the Royal Navy's first destroyers; and Vickers Shipbuilding and Engineering, builders of the Royal Navy's first submarines. Since its formation it has made a number of acquisitions, most notably of United Defense and Armor Holdings of the United States, and sold its shares in Airbus, Astrium, AMS and Atlas Elektronik.

European Aerospace Systems is involved in several major defence projects, including the F-35 Lightning II, the Eurofighter Typhoon, the Astute-classsubmarine and the Queen Elizabeth-classaircraft carriers.

Britten-Norman Group

The Britten-Norman Group is a small company with about 100 employees. It is best known for its design of rugged transport aircraft, such as the Islander, Trislander and Defender 4000. To reduce costs, the company (resident on the Isle of Wight) used not perform manufacture of the airframes, but instead outsourced this to Romania. However, it does has now moved production of all aircraft back to Daedalus Airfield and also performs is the European hub for the Cirrus SR20 and SR22 final assembly and delivery.

Bombardier UK

Bombardier Global 5000

The Canadian company, Bombardier, employs about 5,000 people in its aerospace division in the UK. It can trace its roots back to Shorts Brothers in Northern Ireland. The company has significant workshares in most Bombardier aircraft with its specialities being fuselages and nacelles.

Cobham

Cobham plc employs more than 12,000 people in the UK and elsewhere. Its most important products include refuelling equipment and communication systems.

GE Aviation Systems

GE Aviation Systems, formerly known as Smiths Aerospace, is a division of General Electric, with about 10,000 employees, half of which work in the UK.

GKN

GKN Aerospace is a division of the British company GKN, which employs approximately 5,000 people, mainly in the UK and the USA. In the UK, its most important facility is on the Isle of Wight, where it has a carbon composite centre of excellence. There it designed, and used to produce, the composite wing spar for the Airbus A400M now produced at GKN's New purpose built Western Approach, Bristol site. The company is also known for producing the cell of the Super Lynx and Future Lynx helicopters. It is the former owner of Westland Helicopters.

MBDA

MBDA is the largest European missile house, owned by BAE Systems (37.5%), EADS (37.5%) and Finmeccanica (25%). It operates across Europe, with main capabilities in the United Kingdom, France, Germany and Italy. In the UK, the main sites are Bristol (software and systems) Lostock (production), Stevenage (R&D and integration) and London (management). Modern missile programmes, of MBDA with a British input, are the AIM-132 ASRAAM, Meteor, Storm Shadow, Rapier, Sea Wolf and Brimstone among others.

QinetiQ

QinetiQ is the former Defence Evaluation and Research Agency (DERA). It has close to 12,000 employees and is one of the major players in the British aerospace industry. QinetiQ's main aerospace business relates to satellites, UAVs and reconnaissance systems.

Rolls-Royce

An Airbus A400M, which is powered by the Europrop TP400.

The UK-headquartered Rolls-Royce Group is the world's second-largest maker of aircraft engines (behind General Electric). It has a total of around 38,000 employees, of whom about 23,000 are based in the United Kingdom. The company's main UK factories are at Derby and Bristol. In Derby, the three shaft Trent engines get developed and produced. The current line up includes the Trent 700 for the Airbus A330, the Trent 900 for the Airbus A380, the Trent 1000 for the Boeing 787 and the Trent XWB for the Airbus A350 XWB, among others. In Bristol, the company has concentrated its military aerospace business with the British final assembly line for the EJ200 engine for the Eurofighter Typhoon, the only final assembly line for the British-French Adour engine and other programmes, such as significant parts of the workshare, in the international TP400 turboprop engine for the Airbus A400M and the General Electric/Rolls-Royce F136 engine for the F-35 Lightning II. Recently, Bristol has also been confirmed as the centre for the development and testing of the civil RB282 engine, which will, however, be produced in Virginia