The Pensions Regulator can issue a Financial Support Direction against companies connected to the sponsoring company of a pension scheme if it believes the sponsor is insufficiently resourced.
The Pensions Regulator found that Nortel UK, which since 1991 had increasingly operated as part of Nortel’s single multinational entity, was insufficiently resourced. For 12 years up until 2002, the Canadian parent paid little or no contributions to Nortel UK’s pension plan.
Moreover, the Nortel Group benefited from Nortel UK’s R&D and sales and marketing activities without adequately compensating Nortel UK, and received a £467 million ($744 million) interest-free loan from the UK subsidiary, the Pensions Regulator asserted.
From 1992 to 2000 Nortel Group’s transfer pricing policy with units outside Canada was based on cost-sharing arrangements. TPR drew particular attention to the R&D cost-sharing arrangement and to the European market support group and product line management cost sharing arrangements which covered a range of services provided by Nortel UK to its EMEA partners, including sales and marketing, new product introduction and technical support.
“Evidence was provided that the EMEA arrangements were unusually extensive and differed from the normal arm's-length arrangements between independent companies, because they provided no element of mark-up,” said Lesley Browning, a pensions partner at Norton Rose, a law firm.
“The arrangements in relation to research and development (R&D), being based solely on cost-sharing, did not adequately reflect the value-added contributed by Nortel’s different R&D centres,” Pensions Regulator’s determination panel, an independent body responsible for carrying out the Pensions Regulator’s determinations, found. “While the value of intangibles, like R&D, is difficult to measure, particularly in an integrated group such as Nortel, we accept TPR’s contention that an arrangement based purely on cost did not reflect the exceptional performance of Nortel UK, as reflected in the number of patents per head which it produced.”
From 2001 Nortel Group used a residual profit split model (RPSM) to address the problems of the earlier transfer pricing model. The new method divided the participants' available pooled profits into two main elements of routine profits and residual profits.
“The RPSM regime was criticised, as a sum of £467 million owed by the parent company to Nortel UK built up over several years as a result of unpaid transfer pricing arrangements,” said Browning.
It was found that between 2003 and 2007, considerable sums of money owed to Nortel UK under the RPSM were withheld.
“There was a book entry of the credit due in Nortel UK's accounts, but no cash or other liquid assets were transferred to Nortel UK,” said Browning. “Instead, the amounts due were converted into an interest-free loan to Nortel Networks Ltd in Canada and only partially redeemed in 2007 in the form of illiquid shares in the EMEA companies.”
Despite TPR’s decision to pursue the parent companies, the US and Canadian courts declared the FSD void.
“The pensions world will be watching closely to see what steps TPR takes next,” said Browning. “As the non-UK group companies were found to have benefited from the failure to remedy the UK pension deficit, it is likely that TPR will pursue the FSD against as many of the Nortel Group companies as possible.”
Transfer pricing issues may seem to be somewhat outside the remit of The Pensions Regulator, but they were handled in great depth with the assistance of experts such as Wendy Nicholls , head of transfer pricing at Grant Thornton in the UK, as well as KPMG and PricewaterhouseCoopers.