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.
Stacey Lowman is the head of employee well-being at Claro Wellbeing, a financial wellbeing provider that offers one-to-one coaching sessions, in-person and remote employee webinars and workshops and access to financial courses and content to support employees financial goals.
Claro is offered as an employee benefits package that provides accessible financial guidance and educational resources to help employees feel more confident and supported in their roles, boosting engagement and performance, whilst also enhancing a company's workplace benefits to help retain staff and attract first-rate talent.
Eric Ly is the Founder and CEO of KarmaCheck, a first-of-its-kind company that uses data-driven technology to bring truth, speed, and efficiency to background checks. Ly is the cofounder of LinkedIn, a social networking platform, where he served as the chief technology officer. Ly helped launch LinkedIn from a strategic perspective and assisted with the architecture and implementation of specific aspects of the networking and search algorithms. Ly even acted as the vice president of desktop, building a team of professionals to lead the desktop integrations. Ly attended Stanford University, where he earned his bachelor of science in symbolic systems, and the Massachusetts Institute of Technology (MIT), where he earned his master of science in media arts and sciences. After earning his MS, Ly returned to Stanford to pursue a Ph.D. in computer science. After co-founding LinkedIn, Ly founded Presdo, Hub, KarmaCheck, and several other companies.
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.
