In a pandemic environment, longstanding transfer pricing policies can lead to suboptimal tax results. Multinationals that incur losses in some locations while earning generous profits in others could be overpaying taxes. For many companies, modifications to intercompany pricing that reduce taxes payable and utilize losses are overlooked tax savings opportunities.
A multinational company's transfer prices of goods, royalties, services and loans affect where profits are generated, or the losses incurred in each country. For companies impacted by COVID-19, an assessment of estimated taxes payable and losses by country can highlight tax savings opportunities.
Anna is a Managing Director in Accenture's Insurance practice, based in Milan, and the Executive Sponsor for the Qorus-Accenture Innovation in Insurance Awards. She leads transformation programs for major insurance companies, focusing on data and AI, adoption of digital platforms for managing new risks and the regulatory challenges of the Italian market. Anna has a master's degree in Management Engineering and Financial Management from the Polytechnic University of Turin and a specialization in Financial Innovation Management from SDA Bocconi.
Brad Rapking is the portfolio manager Aptus Capital Advisors responsible for equity research, portfolio reviews and assisting in fund trading and operations. He is a CFA Charterholder and a member of the CFA Institute and CFA Society of Alabama.
Prior to joining Aptus, Brad was a research analyst at Driehaus Capital and a research analyst and equity trader at Opus Capital Management. Brad is a member of the CFA Institute and the CFA Society of Alabama. He graduated from Xavier University with a BSBA in finance.
Reese Harper, founder and CEO of Elements, is 20-year veteran of the financial planning industry and is the creator of the Elements Financial Monitoring System.
For many cross-border businesses, well-established policies have facilitated the pricing of intercompany goods, royalties, and services transactions over many years. However, even the most robust transfer pricing policies were not designed for pandemic-driven closures. As a result, multinational companies have a high global effective tax rate even when incurring company-wide losses. Paying unnecessary income tax bills is particularly painful for those companies already short on cash.
Tangible tax savings
An example may best illustrate the potential for savings from revisiting transfer pricing policies in the wake of the pandemic. In this situation, a wholly owned manufacturer relies on a sizeable cost-plus margin policy when selling inventory to the parent company.
For a subsidiary in a 30 percent tax rate jurisdiction, a $2 million reduction in transfer prices leads to $600,000 in tax savings by utilizing tax-inefficient parent company losses. Corrections to royalty rates and service fees have similar impacts. The result is the same: utilizing tax net operating losses in Country A while reducing Country B’s taxes. That being said, there does need to be economic substance to justify these changes.
Implementing tax savings
Utilizing tax NOLs in Country A while paying fewer income taxes in Country B is, at first glance, a straightforward concept. However, implementing corrections to transfer pricing often requires some planning. In my experience, senior management on both sides of the border needs to be involved in the decision-making process. Other issues, such as adjustments to Customs entries, are additional complications. Transfer pricing documentation is often well-advised support for changes to transfer prices.
Tax auditors may have questions about why transfer prices have changed. COVID-19 has transformed the global business environment, but preparing support to quantify the pandemic's impact on a company is advisable. Furthermore, making modifications before year-end is less complicated than afterward.
Now more than ever, multinational companies should consider modifications to transfer prices when assessing their global effective tax rate; however, changes to cross-border taxes need to be explained. While there are some complications, cash and tax savings can be well worth the effort.
