Now imagine having to do this with multiple countries.
What steps should companies take to avoid double taxation?
As with all intercompany transactions, avoiding adjustments and penalties for services transactions begins and ends with proper documentation. But, as is true with most tax matters, it’s a bit more complicated than that.
For intercompany goods transactions, it’s relatively easy to identify where a good was sold and resold within a MNE’s supply chain and then allocate profit accordingly. For headquarters’ services, however, it must be determined from the pool of SG&A costs how much belongs to each foreign affiliate. This is a multistep process in which each cost center within SG&A must be analyzed to determine:
(1) which services are not eligible for charging;
(2) which services are specific to certain affiliates;
(3) which services are allocable to all affiliates; and
(4) how to allocate services to affiliates.
The best way to satisfy tax authorities on both sides of such services transactions is to analyze the headquarters SG&A cost pool from an activity-based costing perspective. In other words, identify the activities in the cost pool, assign the costs of each activity (direct and indirect) and match them with the consumption of each of the recipients (affiliates).
This is typically performed by not only analyzing cost center data, but also interviewing relevant people within each department and determining what they do and how and how much it benefits each affiliate of an MNE.
It is also prudent to interview employees in foreign- affiliate, service-recipient countries to confirm the benefit and document it accordingly. Typical allocation keys include sales and headcount and may vary by department. Lastly, to be considered “arm’s length,” many of these services may need to have a profit element (markup) in addition to the costs charged.
Once the amounts of the charges are determined, the following documentation should be maintained:
•A well-crafted, clear, concise intercompany services agreement that defines terms and conditions and resembles closely an agreement that would exist between third parties.
•A global transfer-pricing documentation report that describes the services and policies and how the charges were determined (including the markups).
•An intercompany invoice that details amounts and brief descriptions of the charges.
•Any background information that provides evidence of the services and benefits (emails, meeting minutes, etc.).
For an MNE that has never charged for such services, the above process and documentation can seem overly complex and daunting to maintain. However, the first time is the worst, and it may be advantageous for an MNE to take advantage of some of the toolkits that many accounting firms have developed to assist with the process.
The cost of doing nothing grows each year, and the flow of services, along with intangibles, are much more scrutinized by tax than the flows of products.
Kirk Hesser and Michiko Hamada Haney are senior directors at BDO USA. Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.