Archive for BEPS

Simplifying the Rules. A Bit.

Last week the OECD released a discussion draft about how “low value-adding intra-group services” should be treated for transfer pricing purposes (pdf). This document is part of the OECD’s ongoing BEPS project, and represents a substantial piece of output by the group working on action item #10 (out of 15 total): “high risk transactions”.

8161291_sBy way of background, it’s important to understand what is meant by the term “intra-group services”. Nearly all multinational groups have entities that perform services that benefit entities in other countries. Perhaps the group has an R&D center in a country that helps to develop new products for the entire company. Or maybe a local affiliate helps to develop marketing materials for a parent company. Even the performance of order processing, call center, logistics, or other “back-office” type functions by an entity in one country to assist a related entity in another country count as intra-group services. Given the complex web of functions distributed around the world in today’s typical multinational, the scale and scope of such intra-group services are enormous.

Since such transactions are between related parties, they are subject to transfer pricing rules. That means that every time a company or facility in one country performs a function that benefits a member of the corporate group in another country, the service must be paid for in a manner consistent with the arm’s length standard – i.e. as if the transaction had happened between two unrelated companies.  The associated administrative burden to calculate and substantiate that can be substantial.

That’s where the OECD’s latest draft document comes in.  While the primary aim of the BEPS project is to make it harder for multinationals to shift their worldwide income to low-tax jurisdictions and thus reduce their tax bills in ways that are perceived as being unfair, this document actually takes a step toward making life a tiny bit easier for multinationals to meet their transfer pricing regulatory requirements.  The document proposes that there be a simplified way for multinationals to calculate the correct prices to apply to certain intra-group service transactions.

The proposed simplified approach will be very familiar to transfer pricing practitioners in the US, as it is substantially the same as the Services Cost Method (“SCM”) that has been a part of US transfer pricing regulations for several years. The essence of both the SCM and the OECD’s proposed simplified method is to pool the cost of the center providing services, allocate those costs in a reasonable way among the various entities that benefit from the provision of those services, and then possibly add a small markup (in the case of the OECD proposal) or no markup at all (in the case of the US’s SCM).  Importantly, this simplified method is only applicable to services that are considered “routine” and not central to the company’s business.

From my perspective, this makes all kinds of sense. I don’t see any reason for companies to waste time and resources to perform extensive economic analyses supporting their transfer pricing on routine services.  Transfer pricing practitioners have seen so many of these intra-group services (after all, pretty much every multinational company has them) that we can usually tell you exactly what transfer prices the economic research will support even before we’ve crunched the first number.

But this also touches on a couple of larger interesting issues.  First, I think that this marks another step on the path of simplifying transfer pricing by focusing more on outcomes rather than individual transactions. In other words, to me this seems consistent with the continued ascendancy of profits-based approaches over transaction-based approaches to verifying that a company is adhering to the arm’s length standard.

Second, it puts renewed attention where it really should be: on the role and treatment of intangible assets (including their creation, maintenance, and management) when it comes to tax strategies employed by multinational companies.  After all, when you think about today’s most profitable companies, what is the ultimate source of their profitability?  It usually lies with their IP. Most other intra-group transactions are little more than a sideshow and distraction by comparison.

Finally, it’s interesting to note that this may be yet another way in which the US’s transfer pricing rules appear to have foreshadowed developments around the world. The US was one of the first adopters of formal transfer pricing regulations. The US began emphasizing profits-based approaches over transaction-based approaches before most other countries. And now the US’s simplified approach toward low-value intra-group transactions seems to be earning wide-spread acceptance as well.

I think this is simply a reflection of the fact that the US started regulating transfer pricing before most other countries. As a result, the US has had over 20 years to slowly build up a cadre of transfer pricing professionals and a body of institutional knowledge among the IRS, taxpayers, and consulting firms. And with that has come a gradual improvement in our understanding of what works and what doesn’t from a practical point of view.  So it’s worth thinking about how this latest product from the BEPS project may be another small but positive step in the gradual convergence of transfer pricing rules around the world… and to consider that the end result may end up looking more like the US’s transfer pricing rules than one might have expected.

What Is This ‘BEPS’ Thing, and Should I Care?

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You have almost certainly seen news stories recently about how global companies like Apple, Amazon, and Starbucks reduce their tax bills through clever use of international tax planning. You may also have come across the term ‘BEPS’ sprinkled liberally through the business news over the past month or two. If so, your eyes probably glazed over at the time. But since a number of my non-transfer pricing specialist friends have been asking me what ‘BEPS’ actually is and whether they should care, I thought I would take a moment to try to connect the dots and explain what it’s all about.

As these stories about global companies paying little or no tax in certain jurisdictions have become regular front page items in the business press, the issue has drawn the attention of the world’s political leaders. For better or worse (and I think it’s probably for the better – the system is sort of a mess in my opinion), corporate tax policy has become a hot political topic in recent years, as noted by the OECD:

 downloadThe debate over base erosion and profit shifting (‘BEPS’) has reached the highest political level and has become an issue on the agenda of several OECD and non-OECD countries… The G20 leaders’ meeting in Los Cabos on 18-19 June 2012 explicitly referred to “the need to prevent base erosion and profit shifting” in their final declaration. G20 finance ministers, triggered by a joint statement of United Kingdom Chancellor George Osborne and German Finance Minister Wolfgang Shaüble, have asked the OECD to report on this issue by their meeting in February 2013. Such a concern was also voiced by US President Barack Obama in his Framework for Business Tax Reform, where it is stated that “the empirical evidence suggests that income-shifting behaviour by multinational corporations is a significant concern that should be addressed through tax reform”.

In other words, governments around the world have decided that it’s time to consider reforming corporate tax policy.  But since global corporations are, well, global, it is widely recognized that such a project really needs to be internationally coordinated if it’s going to be successful.  That’s where the OECD and its BEPS project comes in.

The BEPS project is essentially a bunch of working groups, composed of officials from the world’s largest economies, that are tasked with the job of trying to figure out how the international tax landscape for corporations should be changed.  They are focusing on a few specific areas, including but not limited to:

  • Tax avoidance by digital companies: Do different rules need to be created to specifically address the digital economy?
  • Financial loopholes: What changes need to be made to prevent companies from using financial instruments like intercompany loans to avoid paying tax on some of their income?
  • Intangibles: Should international transfer pricing norms be revised to make it harder for companies to reduce their taxes simply by moving their intangibles to low-tax jurisdictions?
  • Documentation: What sort of international reporting standards could be imposed to make it harder for global companies to shift their income into low-tax jurisdictions?

In a nutshell, the BEPS project is the attempt by the world’s major economies to try to rewrite the rules on corporate taxation to address the widespread perception that they don’t pay their fair share of taxes.  So despite its opaque acronym, and even though they don’t know it, BEPS is actually something that millions of people around the world feel strongly about.

In future posts I’ll address some of the questions you might be asking yourself at this point, like:

  • Will any of the BEPS agenda items actually result in higher tax bills for global companies, and if so, which ones?
  • Do different rules really need to be created to specifically address the digital economy?
  • Is BEPS a good way to address the issue of corporate taxation?

In the meantime, keep your eyes open for mentions of BEPS in the news.  And the next time you come across that obscure acronym, hopefully you’ll be able to see through it to the substantial international effort to address corporate tax policy that it represents.