Multinational enterprises need to identity all of their intercompany policies, create systems to track their forecast to actual results and have ways to quickly update documentation.
This summer the G8 emerged from their summit with the Lough Erne Declaration, outlining several pain points for governments collecting corporate tax from multinational enterprises (MNEs). A few weeks later, the OECD released its Action Plan on Base Erosion and Profit Shifting (BEPS), which includes 15 proposed actions to reduce international tax avoidance. The G20 has blessed this plan. While the world’s powers agree that BEPS needs to be addressed, the clarity seems to stop there.
What we do know is this: The OECD will establish a working party on aggressive tax planning and look at rules requiring taxpayers to disclose tax planning arrangements. The OECD wants to preserve certainty and predictability for multinationals that make available “timely, targeted and comprehensive information that is essential to enable governments to quickly identify risk areas.” In the action plan, the OECD outlines three major areas of focus: hybrid mismatches, interest deductions and transfer pricing.
In general, this action plan makes clear that multinationals need to start considering the following:
• Transparency in the presentation of financial information, otherwise known as operational transfer pricing, to identify potential areas of conflict such as hybrid mismatches.
• Documentation and reporting capabilities to provide key factual information on intercompany transactions in order to address challenges to interest deductions.
• Clear policies that are managed throughout the organization to address transfer pricing inconsistencies.
Multinationals need to be prepared to prove their transfer pricing policies are arm’s-length with clear, thorough documentation.
Navigating the layers of increased scrutiny and complexity will require a thorough documentation process that provides governments, auditors and the public with detailed information on tax strategies and operational-level execution. This will be a company’s only defense against double taxation, penalties and reputational risk.
Some tips to keep in mind:
• Among the technical transfer pricing issues, the key concern was the suggestion that MNEs have applied transfer pricing rules in a way that separates income from economic activities. Documentation should clearly outline key items, such as identifying the various intangible assets that drive profits and who owns them, as well as the allocation of risks and how that drives the profitability of affiliates.
• A careful functional analysis should be prepared to ensure that the characterization of affiliates is consistent with actual functions and risks. For example, the OECD’s discussion of permanent establishment rules appears to result from a concern that multinationals are treating related party distributors as commission agents.
• The OECD is also concerned about the possibility that income will go untaxed as multinationals structure hybrid financing structures that create interest expense deductions in nations where the financing is treated as debt while receiving equity treatment in the recipient jurisdiction. While the OECD recommends a more coordinated treatment of what intercompany debt should be recognized, its action plan also requires more scrutiny as to whether the interest rate on intercompany loans and intercompany guarantee fees are consistent with the arm’s-length standard. To manage this, multinationals should make sure they properly document the arm’s-length nature of their intercompany financing positions.
This increasingly aggressive environment means MNEs need to identity all of their intercompany policies, create systems to track their forecast to actual results and have ways to quickly update documentation. Companies also need to regularly confirm these policies with workflow tools and have a global repository of information in order to comply with government inquiries. Proving that pricing and strategies are indeed handled at arm’s-length is essential to surviving the coming wave of change in global tax management.