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.
Graham Gordon joined Sapiens in 2021 as Product & Strategy Director for P&C from LexisNexis Risk where he led several new vehicle data and connected car products. Prior to this Graham was part of the Senior Leadership team as Director of Marketing at telematics specialist, Masternaut (Michelin) where he led several key data and analytics initiatives, including forming much of the early analysis and commercial understanding of the value of driver-behavior in the commercial fleet and consumer car sector. Graham holds a bachelor's degree from Lancaster University, post-graduate qualifications from the Chartered Institute of Marketing and more recently completed his master's degree from the University of Cambridge, graduating from the Judge Business School's Executive MBA Program.
As a veteran in the insurance industry, Sean brings nearly 30 years of experience and expertise to Lemonade as Chief Claims Officer. In this role he's responsible for claim handling policies, procedures, and execution across all US and EU territories for Lemonade's full book of insurance products spanning renters, home, pet, car, and life.
Prior to joining Lemonade, Sean spent more than 25 years at USAA holding various leadership positions, the latest being Chief Claims Officer where he had oversight of claim handling for all personal and small commercial lines of business. During his tenure, the company doubled in size, becoming the third-largest homeowners and fifth-largest auto insurer in the US, all while delivering industry-leading loss adjustment expenses and being consistently recognized as the highest rated in claims service by JD Power.
Mike Shultz is a bestselling author of Rainmaking Conversations, Insight Selling, Virtual Selling, and Not Today: The 9 Habits of Extreme Productivity. He is the director of the RAIN Group Center for Sales Research, and president of RAIN Group, a global sales training company that delivers results through in-person and virtual sales training, coaching, and reinforcement.
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.
