From eCommerce to iCommerce: how TP models adapt to persisting inflation and sustainability requirements
Experts from Deloitte’s German TP practice examine the evolution of TP models amid a period of technological, economic and environmental upheaval.
Many would agree that we are living in the age of disruption, and while disruption brings a plethora of opportunities for businesses and society at large, it does pose challenges. The acceleration of key disruptive forces in retail is rapidly transforming the industry while creating new challenges for in-house tax departments who struggle to keep up with the rapid pace of business change. In this article, we discuss three key disruptive forces impacting the consumer industry currently, namely, inflation, sustainability and metaverse, and explore their impact on a company’s tax and TP policies.
An old enemy of consumption that has made a troubling resurgence in recent times is inflation, and businesses across industries are currently struggling to deal with rampant inflationary forces. Inflation is too high and is set to remain so for too long. With input costs growing rapidly, it has been harder for consumers to judge whether price hikes were caused by higher costs or higher profits. At the same time, pent-up demand in reopening sectors, excess savings, expansionary policies, and supply restrictions brought on by bottlenecks gave firms more scope to test consumer demand with higher prices. And while consumers in the recent past have kept up spending, a downward trend may be expected which will impact both top and bottom lines for companies. Another key trend resulting from inflation is that consumers are switching to consumption of own-label goods which will strongly impact the production and procurement strategies of consumer goods companies.
While tackling persistent inflation, consumer goods companies are setting ambitious sustainability goals that require changes along their entire value chain and fundamentally alter the way they do business. For instance, consumer goods companies have over the past years typically built complex global supply chains. To successfully implement their sustainability strategies, they must now undergo a cathartic change in their procurement policies. Consumers are increasingly aware of what makes a product sustainable and therefore demand more information from sellers. Frequent and essential purchases drive the greatest interest in sustainable and ethical values. In this regard, a prevailing misconception is that implementing sustainability strategies is associated with high near-term costs, when in fact well-conceived sustainability strategies focus on value creation through increasing brand value, revenue growth, reducing risks and operating costs.
Sustainability is not the only demand consumers put on companies. The ability to shop anywhere at any time with personalised experiences is no longer a futuristic ambition but a current and pressing demand. The concept of the metaverse has thus gained significant attention in recent years as a virtual world where individuals and businesses can interact in innovative ways. While web 1.0 focused on enabling information sharing and web 2.0 emphasised user interaction, web 3.0 takes this a step further by providing an immersive experience.
Rather than only perceiving digital content via a screen, users can experience an extended reality through additional hardware such as virtual reality glasses and motion sensors. By utilising avatars they can even purchase intangible goods and services (sources: Deloitte, Metaverse report - Future is here, March 2022; Deloitte, A whole new world? Exploring the Metaverse and what it could mean for you, April 2022; Deloitte US, On the board’s agenda – What’s all the buzz about the Metaverse?, March 2022). This transformative virtual space has the potential to redefine social interactions, entertainment, and commerce. However, along with the technical and social considerations, legal implications must be addressed in this new digital realm.
Economic challenges drive proactive adjustment of transfer prices
Multinationals in the consumer industry face various challenges brought by geopolitical uncertainties, a (fading) energy crisis and a persisting inflation that depresses real incomes. In times of increased energy costs and inflation, multinationals examine commercial relationships and related risk allocations between the related parties along the group’s value chain, considering the scope to adjust or renegotiate transfer prices to reflect changed economic realities.
While some sectors in the consumer industry can pass on price increases to customers, others may not be able to do so at short notice. Against this background and within the boundaries of applicable TP regulations, companies analyse whether existing intercompany contracts contain, for example, price adjustment clauses, which would allow them to reevaluate intercompany charges and target margins. Such analysis must consider whether, in third party scenarios, group companies whose functional and risk profiles qualify as routine in nature, would be willing to absorb losses, and if so, under which conditions. This is even more relevant if the economic situation of a multinational is deteriorating, potentially creating a gap between profitable local routine entities and a loss-absorbing principal company.
In these instances, the concept of the prudent business manager may be applied to support a multinational company’s endeavors to allocate respective losses along the value chain. Depending on the functional profiles of the respective group entities and the allocation of risk controlling abilities among them, a sound TP analysis needs to be undertaken and documented to support any local absorption of losses.
In addition, for some countries, upfront alignment with the respective local tax authorities might not only be helpful but even required to protect the multinational company from potential adverse tax consequences resulting from future tax audits. Further, to determine arm’s length pricing, alternative approaches or adjustments to existing comparability analysis may be imperative, e.g. appropriate periods, inclusion of loss makers etc. Finally, to secure funding of future investments and to manage their group’s liquidity, it may become necessary for multinationals in the consumer industry to evaluate their group’s ability to serve debt commitments and to adjust intercompany financing conditions accordingly.
ESG challenges drive recalibration of TP models
Next to mastering economic challenges and their impact on existing TP systems, tax departments in multinational consumer companies are increasingly requested to revise existing TP systems to ensure proper tax treatment of ESG initiatives rolled-out in their groups. As ESG transformation may create new value drivers and usually affects all steps in a group’s value chain, it has become an additional driver for the recalibration of TP models.
From a TP perspective, ESG initiatives may lead to the creation of new cross-border intercompany transactions, for which appropriate transfer prices need to be determined and documented. Further, for newly established ESG functions on management level, tax departments need to determine whether the costs related with such functions would qualify as shareholder costs and as such could not be allocated along the group’s value chain.
ESG transformation is intricately connected to the innovation of new products or processes, and as such may lead to the creation of new IP. Tax departments are required to closely monitor respective initiatives to ensure appropriate identification of legal property rights as well as development, enhancement, maintenance, protection and exploitation of intangibles and risk controlling functions connected to the respective IP to determine appropriate TP models. To the extent a multinational company in the consumer industry has received governmental grants and incentives connected to ESG initiatives, tax departments need to analyse whether the grants need to be reflected in the existing TP set-up, e.g., whether respective funding would need to be considered in the cost basis for routine contract manufacturers. To make appropriate judgments in this regard, tax departments are required to team up not only with the business leads, but also with the group’s legal departments.
Further, regulatory changes, such as the proposal for an EU Directive on Corporate Sustainability Due Diligence may result in companies reorganising their business models. Although the EU legislation process for said Directive is still in progress, some countries, such as Germany, have already introduced national Supply Chain Acts, which companies falling under the regulations need to adhere to (although the Supply Chain Act might need to be adjusted to the EU Directive, once that is finally adopted). Compliance with respective regulatory requirements warrants a holistic view of value chains, eventually leading to recalibration of certain business activities and their underlying TP schemes. Tax departments need to analyse whether such recalibrations may trigger relocation of functions or assets and exit taxes. Finally, tax departments need to be mindful of reporting requirements associated with ESG.
eCommerce: new complexities for tax and TP compliance
Interaction with consumers through the metaverse may create entirely new intercompany relationships and value drivers. Tax departments need to understand these changing intercompany transactions, evaluate appropriate pricing and create documentation.
Within the metaverse, transactions can take place on various platforms and include the sale of tangible or intangible goods, as well as digital services. For instance, customers can browse and select digital replicas of t-shirts within a metaverse digital store using their avatars to evaluate size and fit before adding items to a virtual shopping cart. Customers have the option to purchase the real shirt or a digital replica in the form of a non-fungible token. Payment can be made using credit-cards through a traditional web 2.0 online-shop or cryptocurrencies within the metaverse platform. Various group companies (and third-party service providers) might be involved in the preparation and execution of respective transactions, potentially creating new intercompany transactions and IP, for which appropriate transfer prices need to be determined.
The integration of the metaverse into eCommerce raises questions regarding the taxation of these transactions. Potential tax implications depend on the structure of the transactions and the extent to which the metaverse infrastructure interacts with traditional eCommerce structures. For example, if the virtual presence is merely used as a showroom, while delivery and payment of reals goods occur within the eCommerce infrastructure, this might not lead to new or additional tax consequences. Whereas from a TP perspective, tax departments would need to analyse interdependencies between the sales and marketing activities in the metaverse and in their brick-and-mortar stores, and identify the value contribution of respective activities followed by the determination of appropriate transfer prices.
Furthermore, tax departments might face situations in which tax and TP consequences become increasingly unclear. One of the significant challenges in the context of transactions executed in the metaverse are information retrieval and location of tax jurisdiction. The anonymity of participants within the blockchain infrastructure makes it difficult, if not impossible, to assign individuals or wallets to specific jurisdictions, impeding the evaluation of cross-border cases and determination of tax liabilities for income tax purposes. The location of transactions is also crucial for VAT, considering aspects such as delivery, services and electronically supplied services. Additionally, when cryptocurrencies are a form of payment, it must be evaluated whether these are comparable to legal tender (as decided by the CJEU, in the Hedqvist case) or if it results in an exchange of goods.
Given these complexities, it is essential for tax departments to gather all relevant information on transactions within the virtual sphere to adapt to potential legislative developments surrounding the metaverse. This includes staying informed about tax regulations, tracking transaction details, and monitoring any changes that may arise in the regulatory landscape.
Way forward for tax departments
As discussed, disruptive forces in the consumer goods industry are myriad and rapid. On the one hand, this is a challenge that tax practitioners face, but also an opportunity. To design and implement tax and TP policies that are effective, aligned with value creation and compliant, tax departments must work with in-house business departments to understand early on how business models are adapting to disruptive forces. This business partnering within an organisation is not only one of the cornerstones for transformation of the tax function but imperative for timely risk and reputation management.