Multinational enterprises increasingly face the issue of taxing authorities zeroing in on charges for services exchanged among the entities the enterprises control. Most MNEs have for years dealt with transfer pricing on “intercompany” goods flows, and many have conducted planning involving their supply chains and intellectual property. Yet, few have a handle on intercompany services.
Why should this issue be top of mind today? In the United States, for example, the Internal Revenue Service is taking a hard look at U.S. headquartered companies and whether they are bearing a disproportionate share of the MNEs selling, general and administrative costs. If it decides that they are, the IRS infers that while such services as marketing, accounting, finance, treasury, IT and legal are being performed at the headquarters level, they are also benefiting some or all global affiliates.
At the same time, foreign tax authorities that audit MNEs receiving services charges from U.S. parent companies are very suspicious of such charges and tend to focus on them. The contention from the other side of the intercompany services transaction is that the services are duplicative and/or non-beneficial.
Why could this be a problem?
Suppose the IRS conducts an audit of a U.S.-headquartered MNE and requests transfer-pricing documentation, as they often do. During the course of the audit, the IRS concludes that services are being performed at the headquarters level that benefit the foreign affiliates of the MNE.
The IRS will then compute the amounts it feels should have been charged to the affiliates, such for such services as IT, marketing, finance, accounting and treasury. The sum of these charges would represent a transfer-pricing adjustment, while the expenses relating to these amounts that were taken as a deduction on the U.S. corporate tax return would no longer be allowed.
That scenario could very likely result in additional U.S. taxes owed by the MNE. Further, since the intercompany charges were not actually made, none of the foreign affiliates of the MNE would have deducted the expenses related to these charges. The result would be that the same profits have been taxed twice — the worst possible answer for an MNE striving to maintain an efficient worldwide effective tax rate.
To top things off, the U.S. MNE would also be eligible for transfer-pricing penalties and interest on the additional tax owed, both of which are non-deductible. The only remedy to fix the double-tax situation is an expensive and time-consuming process within the mutual agreement procedures of tax treaties between countries. Obviously, this remedy is only available where there is a tax treaty between two countries and, even that case, it would likely take years resolve.