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.
Mark Piszko, CPA, is a partner at PKF O'Connor Davies. He has nearly 40 years of experience in providing auditing and consulting services to a wide variety of not-for-profit entities, including charitable organizations, religious entities, educational and cultural institutions and social services agencies that receive government funding. He is the partner-in-charge of the firm's not-for-profit practice area and is the firm's quality assurance partner for single audits.
Joe Crawford is Director of Professional Services at Glassbox, where he helps banks and financial institutions unlock insights from customer engagement data. He brings over 20 years of experience in enterprise monitoring, digital analytics, and performance engineering from leadership roles at Citi, Morgan Stanley, and AT&T. Joe specializes in applying behavioral data and AI to improve digital experiences and reduce operational risk.
Chintan Shah leads Bloomberg's product strategy for buyside Treasury, Asset-Liability Management (ALM), and Finance solutions, with a focus on Insurance General Accounts, Pension Funds, and institutional cash management. With over 16 years of capital markets and investment management experience, Chintan brings deep expertise in serving the needs of asset owners and asset managers.
He has spent the past eight years at Bloomberg, driving product innovation and client engagement in the ALM and Investment risk space. Prior to Bloomberg, he was part of the Overlays and ALM team at AIG Investments, where he worked on optimizing balance sheet and liability-driven investment strategies. Chintan began his career in interest rate derivatives trading and risk management, holding roles at Barclays and Deutsche Bank.
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.
