Multinational groups, particularly those operating in the technology and digital sectors, where a large portion of the value lies in intellectual property, are facing increasing scrutiny, suspicion, and public resentment about the levels of tax they pay. The OECD's ongoing base erosion and profit shifting project may lead to changes in the laws and available guidance, but in the meantime taxpayers need to focus on how well they have embedded their transfer pricing policies into their business functions.
Over the last few years, the global recession and consequent fall in tax revenues has led the world's NGOs, politicians, and media to focus on the relationship between revenues generated and corporate tax paid in their countries by multinational groups. Transfer pricing, and in particular the structures and policies adopted by companies in the technology and digital sectors, have received considerable attention in this debate.
One of the public challenges in the UK is that, whilst the taxable profits reported may be in accordance with current international tax laws, and so are not illegal, the resultant low levels of UK corporation tax paid (relative to UK turnover) are seen as potentially "immoral." Because of their high volume of trade with UK customers, multinationals are perceived to be benefiting from the UK infrastructure and economy without making a reasonable contribution to sustaining that environment.
After acknowledging that the international tax laws, treaties, and guidance designed by bodies such as the OECD and implemented by national governments have not kept up with modern technologies and commercial practice, governments have pledged support for an in-depth review of various key areas to address base erosion and profit shifting (BEPS). The areas to be worked on will be discussed at length over the next few months, but in the meantime companies need to consider whether the policies and practices they have in place to underpin their transfer pricing arrangements are being correctly implemented within their business by their employees.
Whilst each multinational's case will be dependent on specific facts, for technology and digital companies it is not uncommon for sales to customers in one country to be made by a group company in another country. It may also be the case that there are significant markets in some countries that have to be supported by substantial, valuable activities. Furthermore, underlying intellectual property may be a key driver of sales, and that property may or may not have been developed and owned in the same country as the sales. These fact-specific scenarios lead to questions regarding the value chain, focusing on the nature and importance of activities taking place in different locations, particularly where high-value activities and/or assets have been centralised or are in a low-tax jurisdiction.
Such business models, if implemented effectively, should fall clearly within international tax rules and transfer pricing guidance to support the allocation of taxable profits between the relevant jurisdictions. However, with significant amounts of money potentially at stake, tax authorities are starting to focus increasing scrutiny on whether or not the people within each business are actually operating in accordance with their documented transfer pricing policies, or whether their activities in practice suggest a different allocation of profit.
Developing and managing transfer pricing policies
As part of the scrutiny of companies' activities, tax authorities, the media, and politicians are looking at all available public sources of information that may provide insight into where sales are concluded or other valuable activities take place. This includes all public statements made by the company but as has recently been observed, also extends to profiles of employees on recruitment-based social media sites where they describe their roles and experience. It is important to bear in mind that the main purpose of such sites is for people to advertise themselves through what is effectively an online curriculum vitae/resume. It would not be unusual for individuals to present their role and responsibilities in the most favourable light, and to make themselves appear to be more crucial to their employer's business than they actually are. However, these potential anomalies and inconsistencies could lead a tax inspector to conclude that there may be an argument for a greater allocation of profit to a particular group company, or for the existence of a permanent establishment.
So what could companies be doing now whilst waiting for the conclusion of the BEPS review to better position themselves with tax authorities? In the first instance, ensuring they have in place a strong transfer pricing control framework will aid in preventing and detecting issues, as well as providing a robust defence structure.
A good control framework includes clear transfer pricing policies; a record of any exceptions to those policies that prove necessary on implementation; identification of all transfer pricing stakeholders across the organisation; clarification of the responsibilities of these stakeholders; identification of transfer pricing risks faced by the business; and an effective method for communicating across all stakeholders.
It has always been important to make sure there are clear policies around activities, autonomy, when and where additional authorisation is required, etc. but taking active steps to engage and ensure that these policies are communicated to, understood, and accepted by the business people does not always get the attention it should. Identifying the key stakeholders in the tax and finance functions and within commercial teams, attributing responsibility for transfer pricing to them, and establishing a communication forum for this stakeholder group are critical to ensure that transfer pricing policies are followed as intended by the tax team. With the recent increasing profile of tax and transfer pricing policies it is essential to not only have such a stakeholder group in place but also to ensure it includes senior – ideally, board-level – representation so that it carries the appropriate weight and influence within the group.
Using a structured discussion and communication forum during development of the transfer pricing policies will help ensure that those people setting the policies understand how the business needs to operate to be successful. It is very important that the commercial teams do not feel stifled by overly restrictive rules introduced to meet a tax objective, as that is when there is most risk of the policies not being followed and potential tax exposures arising. It is easy for a team that is disconnected from the day-to-day activities to devise rules that will deliver the lowest tax cost "within the letter of the law," but if this is not compatible with the way the business needs to operate, changes should be made even if this results in a higher tax charge.
Maintaining a dialogue between tax, finance, and commercial teams after the transfer pricing policy implementation is an effective way to ensure that the business continues to conduct its value-adding activities as documented in the transfer pricing policies or, where issues do arise, to make appropriate changes. It is the responsibility of all transfer pricing stakeholders to escalate concerns when reality does not meet policy.
Monitoring transfer pricing policy compliance
Creating or updating the group's social media policy is an excellent way to communicate the importance that people within the group not only demonstrate they are performing activities as per their role profile but also refrain from misrepresenting their role in a public forum. It is difficult to control what employees post on social media, but enforcing a social media policy with periodic reviews of what is being said about employee roles as part of a broader monitoring activity will help mitigate the risks of invalid information about the business circulating in the public domain.
Whilst comments made on social media can be discounted if they do not reflect the underlying business practices, tax authorities are increasingly using software tools to interrogate email systems and review discussions that might cast light on how a business actually operates. This could relate to a sales process, where absolute clarity around the responsibilities for marketing, opportunity development, negotiating, and concluding sales is critical to the outcome under transfer pricing principles, but also has significant impact in other areas such as intellectual property ownership and company residence.
Many businesses in the technology sector operate a policy of centralised intellectual property ownership, with the ongoing development undertaken by contract R&D entities or under a cost sharing arrangement. It is important for such groups to have key people involved in their intellectual property development and exploitation strategy located in the territory of ownership and to evidence that they are making key decisions. Technology, and in particular the ways people can now communicate, has blurred the lines around where board meetings are held, or where board members are when the meetings are held. This can then raise questions about where effective management and control (for purposes of establishing tax residence) is actually being exercised.
Periodic post-implementation reviews can help to identify any areas in which the business is not operating as documented, and to provide a clear indication of risk areas that should be addressed. Technology is providing new solutions that are ideal for scanning and analysing large volumes of data, and it is likely that many of these features are available on finance systems that are already running in house. If such facilities are not already available, groups should consider licencing the sort of software packages that are being used by tax authorities and many others to successfully extract key details such as decision making correspondence and travel details to monitor their own compliance.
In addition to reviewing compliance with the overall tax and transfer pricing policies, it is important to monitor individual companies' profitability levels, ideally on a dynamic basis during the year, to ensure they are in line with expectations. Processes for extracting and analysing the relevant data in an efficient, and ideally automated, way that minimises disruption and provides as close to real time information as possible are invaluable in avoiding surprises. To the extent the actual out-turn is not as expected or does not look appropriate given the overall fact pattern, a regular review during the year can ensure that anomalies or deeper issues are identified and dealt with appropriately and on a timely basis rather than as post-year-end adjustments.
A robust method of monitoring transfer pricing policy versus business operations and taking early action is the best defence. A software solution, such as an appropriate data analytics tool, may provide a useful way for the tax team to review past activities, monitor results on a dynamic basis, and also model the impact of future business change on current transfer pricing policies. Tools such as these can store the transfer pricing policy details and general ledger data that, when supplemented with actual invoices and any other business relevant data, make the continuous monitoring of policy versus reality possible.
The technology sector faces additional challenges with monitoring compliance with transfer pricing policies because it is such a fast-moving industry with rapid changes in business models, new tools available to conduct business, and M&A activity that can change the profile of a group dramatically. These factors can have a significant impact on the tax profile of a group and introduce new commercial drivers that may render existing transfer pricing policies unsuitable or impractical.
Perhaps ironically, the tools and capabilities being made available by groups within the technology sector are providing tax authorities with significantly enhanced abilities to undertake in-depth audits, but they are also available for companies to use for their own pre-emptive monitoring. Using technology and keeping the lines of communication open between all stakeholders, with sufficient senior management involvement, is the safe bet for these times of increased scrutiny.
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