Tag Archives: international groups

International Group Audits – how do we overcome location-based challenges?

The impact of COVID-19 continues, but it is important that is does not undermine the delivery of high-quality audits. For auditors of international groups of companies there is an added challenge of different locations and jurisdictions.

In an international group there may be a significant subsidiary company in a different country audited by a different firm of auditors. How will the group auditor satisfy themselves on the competency and work undertaken by the subsidiary auditor? In the past local site visits to the subsidiary company and auditor have provided a solution. This has enabled the group auditor to review key audit working papers and attend closing meetings with local management. With COVID-19 that is no longer an option, or at least unlikely. Where does this leave the group auditor? How can they continue to provide a quality audit service?

For many the answer lies with technology. The speed which businesses have embraced technology and new ways of working together is unprecedented during COVID-19. Each individual group audit needs to be considered on a case by case basis, but technology can provide the means to overcome geographical restrictions.

Emails and conference calls are a norm in business, but they are limited. Zoom style video conferencing and screen sharing provides a greater opportunity for the group and subsidiary auditor. Electronic documents can be shared on screen, discussed and questions answered. Each member of the group and subsidiary team can contribute and answer questions where needed. Cloud-based portals allow files to be shared and information exchanged securely. With more finance systems becoming cloud based it is even possible for management to provide information directly to the group auditor for testing.

With the ongoing digital transformation of business, I have no doubt that new and even better ways will be developed to work together and overcome geographical restrictions. That should provide even better means to overcome location-based challenges such as COVID-19.

Possible Tax Impact of a No Deal Brexit on Groups

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James Hallett’s excellent blog on preparation for a No Deal Brexit highlights some of the practical consequences which should be considered by 29 March. James highlighted practicalities for import/export and financial reporting.

Group structuring and group cash flows may also be impacted by a No Deal Brexit.

Group structuring

Some EU countries’ domestic legislation provides specific reliefs if the counter-party is in the EU. These reliefs may have been relied upon for past transactions and reorganisations. As the UK may no longer be classed as an EU counter-party this may result in clawback of a relief which has been relied upon. Sticking to this theme, there may well have been migration involving the UK which has relied on tax deferrals under the EU freedom of movement. The UK’s departure from Europe may put the availability of those deferrals at risk and generate unforeseen tax liabilities.

At a more esoteric level the existence of a UK subsidiary, which is no longer within the EU, within a European group may adversely affect treaty benefit claims under double tax treaties involving EU countries and the US. The reliance on such treaties and the consequence of the UK’s departure from the EU should be considered.

Group cash flows

At a more basic level dividend, interest and royalty flows may rely on the EU Parent Subsidiary Directive or the Interest and Royalty Directive to prevent the application of withholding taxes. With the UK leaving the EU the ability to apply the terms of these directives would be at risk.

Without the benefit of the directive it would be necessary to consider the double tax treaty which the UK has negotiated with the counter jurisdiction to determine the extent to which there is a reduced rate of withholding tax provided under the treaty. This is particularly of concern if debt has been obtained from elsewhere in the EU and the terms of the loans include a gross up clause for interest. If the treaty reduces the domestic rate of withholding tax then the process to obtain treaty benefit would have to be followed. There are varying processes and varying time frames required to access treaty benefits.

Election to tax the overseas dividend

A solution which is relevant for dividends received in the UK is the election to tax the dividend received from overseas. This might be beneficial as a small number of treaties require dividends to be taxed in the UK in order to qualify for reduced rates of withholding tax. Mathematical modelling could be undertaken to determine if it is more advantageous to pay 19%/17% on dividend income and have a reduced withholding tax or have the dividend exempt from UK tax but suffer the foreign withholding tax.

The above are a flavour of the myriad of direct tax consequences of a No Deal Brexit and show that there is no one size fits all solution for business. Each business should review its structure, past transactions and internal fund flows in order to determine the cost versus the benefit of No Deal planning.

Higher or Lower? Getting the price right for intra-group transactions

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Setting the right price for transactions between group companies is one that many boards ask themselves in order that each group company’s profit and loss fairly reflects the underlying nature of transactions. For many items an external market can act as a reference point, making this task relatively straightforward. However, this becomes more difficult when dealing with more complex transactions such as:
• Recharging management team time
• Recharging rent
• Charging for the use of intangible assets such as customer lists or licences
• Provision of finance amongst group companies
For these transactions it is not just the directors of companies that get vexed by the question of what is the right price?

International Groups in HMRC’s sights

Where groups trade internationally, the disparities in global corporation tax rates provides for groups to take advantage of more favourable tax rates. Therefore, unsurprisingly tax authorities take a keen interest in the amounts charged for intra-group transactions. In the period between 2011/12 – 2016/17 HMRC secured an additional £5.9 billion of tax receipts by challenging the transfer pricing arrangements of multinational trading groups.
Therefore, what can international groups do to get the price right? And avoid both the time and expense of a tax enquiry.

Exemptions for SMEs not straightforward

Firstly, the good news is in the UK, HMRC provides an exemption to most small and medium size enterprises (SMEs). To qualify as medium the business will have no more than 250 employees, annual turnover less than €50 Million and a balance sheet of less than €43 million.
However, this UK exemption may not apply in the following circumstances:
• Transactions with overseas subsidiaries where the UK does not have a double tax treaty including the appropriate non-discrimination article
• Where HMRC has issued a transfer pricing notice to an SME which is party to a transaction relevant to a patent box claim
• Where an SME elects that the exemption from the transfer pricing notice should not apply
• Where HMRC issued a transfer pricing notice to a medium sized enterprise
Furthermore, while the UK has an SME exemption, not all territories have one and their thresholds may stipulate different criteria. Therefore, where a group trades globally it is worth considering this issue even if at first glance it seems the SME exemption is available.

OECD Guidelines

The first port of call for determining the right price are the OECD [Organisation for Economic Co-operation and Development] guidelines. These are globally accepted as the bible for providing methodology on calculating an appropriate price and the documentation which needs to be in place. Allowing for review of the pricing policy following its implementation and ongoing monitoring. At their core is the principle that transactions are at arm’s length.

Advanced Pricing Agreements (APAs)

After determining an arm’s length pricing policy, to provide additional comfort that the price is right, a group may wish to obtain an advance pricing agreement (APA) from tax authorities. Thereby agreeing the principles for calculating the price with the tax authority. The degree of certainty obtained can vary from non-binding opinions through to a form of advanced clearance on the transfer pricing policy. HMRC does not offer a simplified process for SMEs for an APA. However, other territories such as France and the USA do provide a streamlined APA process for SMEs. While, APAs do add an initial administrative burden, the clarity they provide on whether the price is right, avoids any nasty tax surprises further down line.

Overall setting the right price for transactions between group companies is not straightforward and is an issue which tax authorities globally are increasingly taking a keen interest in. Even where groups may be able to take advantage of the UK SME exemption, when trading internationally, groups need to be vigilant that these exemptions apply in other territories. Where groups do need to consider an appropriate transfer price, the best starting point are the OECD guidelines, which at their heart are based on the arm’s length principle. Finally, having determined an appropriate transfer pricing policy, to mitigate against any nasty tax surprises down the road it is worth considering obtaining an advance pricing agreement from the relevant tax authorities.

Part of an international group? – better watch those cross-charges!

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Ever since the financial crash, there’s been increasing pressure on international groups whose tax bills seem too low. The word “morality” has regularly fallen from the splenetic lips of outraged politicians, furious that the tax structures their colleagues have created have been used in a way they’d claim was never intended. Behind the scenes the OECD has been looking at ways to limit the extent to which profits can be shifted from one territory to another without in any way prejudicing the right of sovereign governments to entice business to their territories by way of tax incentives. It’s a hard task, but a start has been made with BEPS Action 10.

BEPS Action 10

An OECD discussion document succinctly titled “BEPS Action 10: PROPOSED MODIFICATIONS TO CHAPTER VII OF THE TRANSFER PRICING GUIDELINES RELATING TO LOW VALUE-ADDING INTRA-GROUP SERVICES” has just been issued. Its 20 pages seek to define low value-adding intra-group services, how they should be documented, and the appropriate margins. Furthermore, it defines what is described as “shareholder activities” which shouldn’t be cross-charged in the first place.

This document raises some interesting points. Its description of Shareholder Activities includes the phrase “an intra-group activity may be performed relating to group members even though those group members do not need the activity (and would not be willing to pay for it were they independent enterprises)”. It goes on to say “This type of activity would not be considered to be an intra-group service, and thus would not justify a charge to the recipient companies”. It lists examples, which include “costs relating to reporting requirements (including financial reporting and audit) of the parent company … and costs relating to the preparation of consolidated financial statements of the MNE (however, in practice costs incurred locally by the subsidiaries may not need to be passed on to the parent … where it is disproportionately onerous to identify and isolate those costs)”

Whilst the logic behind the first phrase is undoubtedly sound, the second one rings alarm bells. A quoted parent company will typically have quarterly reporting requirements that oblige its subsidiaries to undertake work and be subjected to quarterly review by their auditors. Those auditors will bill their client – the subsidiary – for their efforts. Those bills are readily identifiable. The auditor’s client would most certainly, were it independent, be unwilling to pay the charge as it arguably receives no benefit from the service performed. I have never seen such charges recharged to the parent, nor have I seen them disallowed in computations of taxable profits. Yet the implication of the bracketed comment is that these will no longer be allowable expenses of the trade of the subsidiary.

Duplicate Services & Incidental Benefits

The document then discusses duplicate services (if genuinely a duplication of what the group member has already done, no cross-charge), and incidental benefits (where benefits flow to a group member as a by-product of services targeted at another group member or members, again no cross-charge) The latter includes not only the benefit of enhanced credit-worthiness resulting merely from being a member of a substantial group, but also the boost to its trade from group reputation-building achieved by global marketing and PR campaigns.- the implication being that the parent should bear all the costs of brand promotion whilst the beneficiaries (its various subsidiaries) bear none. That seems more than a little draconian.

Centralised Services & “On call” Charges

The document also discusses centralised services and “on call” charges, prohibiting neither, but saying the fact of payment being made or liability recorded for intra-group service provision does not provide evidence that such service has been supplied, any more than their absence is evidence that no such service has been supplied. This would seem to imply that if proof of supply existed even where no cross-charge had been rendered, a tax deduction might still be possible – more likely, however, is the alternative implication that where a supply can be seen to have been made but no charge rendered, the supplier should be deemed for tax purposes to have some level of undisclosed income.

The document then discusses pricing – no surprises there, equivalent arm’s-length is best, but in many cases can’t readily be achieved. The result is indirect-charge methods.

Low value-added Intra-group Services

The real meat of the document relates to its suggested simplified technique for MNE’s to quantify and allocate low value-added intra-group services. The simplified technique should be applied on a consistent group-wide basis across all countries in which the MNE operates. It summarises low value-added services as being supportive in nature, non-core activities, not utilising unique and valuable intangibles, and relatively low-risk. By topic, it suggests these will include:

Accounting and auditing
Budgeting
Accounting processes
HR
Health and safety and other regulatory compliance
IT services
Communications both internal and external including PR support, group legal services group tax services
General admin/clerical services

The simplified technique requires the MNE to calculate on an annual basis a pool of all such costs, by category and by accounting cost centre. The pool should exclude costs benefitting solely the company that incurred them, and costs benefitting solely one other group company.

Having established the pool of low value-added costs, the MNE should then establish appropriate allocation keys per category (payroll provision – staff numbers, IT support– computer expense, accounting services – transaction volumes, and so on).

The MNE should then apply a mark-up. – No less than 2%, no greater than 5%.

These steps should all be documented, and the documentation made available on request to relevant tax authorities. The documentation should explain:

What services are involved and why the MNE considers them to be low value-added
The rationale for pooling service provision across the members of the MNE
Description of expected benefits
Description of the allocation keys used and why those keys should produce outcomes related to benefits received, and confirmation of the mark-up applied.

The documentation should also include:

Written contracts or agreements for the provision of these services from participating group members
Calculations of the pool, and of the application of the allocation keys.

If adopted, the OECD believes BEPS Action 10 should satisfy tax authorities across the world that all such cross-charges have been allocated appropriately and that no profit-shifting has occurred to the detriment of any individual territory.

We can but hope.