Intercompany tax and operating efficiency

June 2022  |  TALKINGPOINT | CORPORATE TAX

Financier Worldwide Magazine

June 2022 Issue

FW discusses intercompany tax and operating efficiency with Kristine Riisberg, James Phillips, Anis Chakravarty and Carlo Navarro at Deloitte.

FW: Could you provide an overview of recent global tax reforms and their impact on intercompany accounting practices, particularly their tax functions?

Navarro: The most recent global tax reform is the Organisation for Economic Co-operation and Development (OECD) and G20-led two-pillar framework to address the tax challenges arising from the digital economy. Pillar I focuses on new nexus and profit allocation rules to assign a share of taxing rights to market countries that would have difficulty in taxing digital income. At the same time, Pillar II aims to ensure that all global business income is subject to an agreed minimum tax rate that will prevent a race to the bottom. While current tax systems treat multinational enterprises (MNEs) as a collection of multiple legal entities following separate accounting practices, these global tax reforms treat MNE groups as a single unit to allocate income and pay taxes. These taxing rules require harmonised accounting practices across the group and limit ways to structure intercompany transactions for tax efficiency purposes. The focus of tax functions shifts from managing multiple unilateral tax issues to monitoring the implementation of multilateral tax measures, with increased outsourcing and automation of routine activities.

Phillips: The latest round of tax reforms, for example US tax reform, the introduction of digital services taxes by some countries and OECD-led changes among others, continues a general trend of increasing change for finance and tax departments. Groups will need to assess if, and how, these changes could apply to them, and what changes, if any, are necessary to their finance or broader intercompany processes to comply. This is likely to mean more effort required by the finance and tax functions, or potentially a need to consider outsourcing certain components of any new processes. It may also require increased collaboration between finance and tax departments as they need to better understand each other’s obligations and constraints in order to appropriately comply with new requirements.

Riisberg: The OECD/G20 Base Erosion and Profit Shifting (BEPS) project issued 15 reports in 2015 that have had a significant impact on the tax function as it relates to intercompany transactions. The reports covered a variety of technical topics that have been widely implemented in domestic legislation around the world and cover topics such as how MNEs must price transactions involving intangible property.

Chakravarty: To bring the digital economy under the global tax net, the OECD has introduced a two-pillar approach, which has been granted consensus by 130 countries. Pillar I provides taxing rights to market jurisdictions on part of the residual profits, while Pillar II requires specified MNE groups to pay at least 15 percent tax. This is one of the most significant global tax reforms proposed in recent times. MNEs will need to analyse the impact of Pillar I and II on their businesses and align their accounting data with tax data, which will require efficient data collation. Challenges will be faced due to local and group generally accepted accounting principles (GAAP), requiring MNEs to bridge the gap, reconcile deviations and recompute income as per two-pillar reporting requirements. Thus, it will be critical for MNE groups to revisit their accounting and enterprise resource planning (ERP) systems to ensure efficient data management to comply with new requirements.

FW: How would you describe the likely impact of the Organisation for Economic Co-operation and Development (OECD) reforms to the international tax system, such as Pillar I and II?

Phillips: One of the expected impacts of the OECD Pillar I and II reforms is the large amount of data that businesses will need to gather in order to comply. Some groups have already begun to look at these aspects and to consider the application of Pillar I and II to them. What these reviews have highlighted is the wide and varying range of sources of required data, some of which may currently not be available. In-scope groups will need to build and implement new processes to capture the necessary information to be able to comply with the new requirements in as efficient a way as possible. For some groups, Pillar I and Pillar II could result in tax being paid in different jurisdictions than is currently the case, and potentially more tax overall. Assessing the potential effect of the rules at an early stage should allow groups to consider what, if any, appropriate actions should be taken now.

Chakravarty: Given the widespread consensus regarding the two-pillar approach, its implementation will impact existing local tax laws. Amendments will be required to local tax laws to align with Pillar I and II recommendations. For inclusive framework members, the two-pillar recommendations are likely to be implemented in-country. Taking India as an example, Pillar I implementation will impact existing provisions of the equalisation levy (EQL). India had introduced the EQL provisions with the intention of taxing the digital transactions in India. With the implementation of Pillar I, India may have to abolish the EQL provisions. Similarly, Pillar II implementation will involve recomputing tax liability at the group level. MNEs will need to study the overall impact to make requisite updates to their tax provisioning tools. They will also have to keep a record of taxes paid across jurisdictions and factor in deductions for taxes already paid in order to avoid double taxation.

Navarro: The most likely impact from Pillar I is the equitable allocation of taxing rights between source and residence countries. It provides an opportunity for market jurisdictions, which are mostly developing countries, to tax highly digitalised businesses which would have been difficult under the current international tax system. Pillar II, on the other hand, will address the issue of the race to the bottom that prevents developing countries from generating sufficient tax revenue. If implemented correctly, developing countries will be able to generate revenue to help their crippled economies and to compete based on their local advantages.

Riisberg: It is too early to assess the impact of Pillars I and II. A political agreement was reached among about 130 countries during 2021 but the proposed changes have not been implemented anywhere because technical work is ongoing. Pillar II seeks to impose a minimum tax on corporations wherever they operate and is further advanced than Pillar I. If successful, Pillar II will make it more difficult for MNEs to achieve very low effective tax rates.

FW: How would you characterise the alignment and consistency of international tax frameworks? What compliance challenges does the tax landscape pose for multinational companies?

Riisberg: In 2017, the OECD fronted Chapter 5 with the new transfer pricing (TP) documentation three-prong requirements – master file, local file, and country-by-country (CbC) reporting. This was in an attempt to get everyone internationally on the same page, increase alignment and transparency, have a new cut on the data, and make analyses more objective and equation-based. However, shortly after the introduction of BEPS Action 13, many countries introduced their own nuances to what the OECD hoped would be a streamlined approach, and now, five years later, local regulations are even more dispersed. These nuances lead to challenges in tracking deadlines, aligning content, and understanding differences in requirements, creating more of a need for global coordination. It is also critical that companies are confident that the TP forms filed with their tax returns are aligned with the relevant information shown in the TP documentation files.

Navarro: Tax leaders across the world need to deal with the challenges arising from inconsistent international tax frameworks. The implementation of BEPS 2.0 could potentially give rise to inconsistent detailed local implementing rules. This will depend on how countries will interpret the rules and adopt them in local legislation. The compliance challenge in this case is how to harmonise these detailed implementation rules. Different legislative processes and systems may result in differences in the timing of implementation of BEPS 2.0. Differences in the timing of implementation can also cause challenges in terms of disclosures required by the different applicable rules at a certain period. Finally, tax leaders will also need to understand how to harmonise the different disclosure requirements under international tax frameworks, such as the OECD and the European Union (EU) CbC reporting rules.

Phillips: The potential advantage of having internationally agreed tax legislation is that only one set of rules needs to be considered across multiple countries, rather than each country’s local rules separately. However, even with an international tax framework, the adoption of international rules and their application can differ between countries. Therefore, an international framework can ease global tax compliance to a degree, but it is still important to check the local position. Globally operating businesses are used to needing to adapt their products – in terms of size, brand, labelling and local regulatory characteristics – to meet local needs. International tax departments are going to need to be as adaptable as ever as they are even more often asked to meet a similar type of challenge.

Chakravarty: Consistency and alignment of international tax frameworks is critical to avoid any potential double taxation or double non-taxation for MNE groups globally. With the objective of swiftly updating the bilateral tax treaties and international tax rules to lessen the opportunities for tax avoidance by MNEs, the OECD introduced a key action plan in the form of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). Many countries have concluded negotiations and implemented the MLI. With the implementation of the MLI, MNEs are now facing a new set of challenges to comply with the updated treaty provisions. MNEs now need to identify which countries have implemented the MLI, from which date the MLI has been implemented and which provisions are implemented, to determine applicable governing provisions. Therefore, albeit under an overall international tax framework such as the MLI, such practical issues still pose challenges for MNEs.

FW: With significant pressure on companies to manage compliance, what steps should they take to improve their tax planning and documentation processes? How important is it to harmonise tax and transfer pricing strategy across parent and subsidiary companies?

Navarro: With increasing pressure to manage compliance, MNEs may centralise the tax function to centres of excellence or shared service centres and adopt technology that extracts, processes and reports data in real time. This will allow an MNE to consistently apply its policies and strategies. Outsourcing or co-sourcing is also an option if in-house capability is not present. Tax and TP policies need to be managed centrally to the extent possible to ensure policies are consistently applied. This will help businesses to have a clear, well-documented policy and other supporting documentation that is ready in the event of a tax dispute.

Chakravarty: Standardisation of policies will ensure consistency in tax and TP positions adopted globally and will facilitate holistic tax planning for MNEs. By adopting a centrally managed tax and TP operating model, MNEs will be able to standardise and align local policies with group policy. One of the pillars of the BEPS action plan is transparency, which is being driven through actions such as the MLI and CbC reporting. Implementation of CbC reporting, including master file preparation, requires MNEs to collate and report consolidated group information. With this three-tier documentation, it is imperative for MNEs to harmonise their tax and TP strategy across parent and subsidiaries. For efficient preparation of comprehensive CbC documentation, MNEs require robust systems with strong internal controls to comply and report data globally and consistently. Increased compliance, heightened litigation, increased global transparency and automatic exchange of information between tax authorities, all make it imperative for MNEs to harmonise their tax and TP strategy across jurisdictions.

Riisberg: In today’s environment, having rigorous documentation of changes to price setting, intellectual property (IP) ownership, and management and control of functions, risks and assets as an effective tax optimisation strategy, can significantly reduce the risk of costly problems, including penalties. Documentation and a robust planning strategy work in tandem in today’s rigorous tax compliance landscape. When optimising a tax strategy, it is critical to harmonise the tax and TP structure and policies across the parent, hubs, entrepreneurial entities, IP owners, research centres, limited risk entities and general subsidiary companies, as well as understand where profits should be earned. In order to not have a one-sided view, a company must coordinate across jurisdictions and across internal departments. Companies should consider the tax and TP implications of their tax optimisation and prepare documentation that rationalises why they chose one option over another, which helps set the story for their position. Companies should also bear in mind that separate tax and TP analyses may be performed among states in the US, which can deviate from the international structure, adding a further level of complexity to the storyline in international and domestic TP documentation files.

Phillips: Having a harmonised tax and TP strategy across a group can yield substantial benefits. One immediate example would be that the increased tax coherence across the group should help reduce tax controversy risk. The tax function requires reliable legal entity financial information. However, such data is normally within the purview of the finance department and is seldom prepared as part of broader finance forecasting processes, which tend to be focused on management needs. Similarly, information required for TP documentation is often held within finance systems but may not be collected as a matter of course. To improve both aspects, developing effective working practices between tax and finance can be key. Tax and finance key stakeholders should seek to improve understanding of each other’s requirements and constraints. From this, with suitable senior support, individual tasks – and the associated budget to perform them – can then be allocated based on who is best placed to deliver.

FW: In what ways can digital transformation, particularly adoption of automation, assist companies to improve efficiencies and allocate resources more effectively? How can tax functions prepare to meet the demand for real-time audits, for example?

Phillips: As with all other parts of a business, with the right investment, digitalisation and automation can yield substantial benefits for the tax function. One example often seen in this space is where a business has built up spreadsheet-based TP models over time. Making calculations in the spreadsheets may require several person-days and, as they are manual processes, is susceptible to human error. Consistency in treatment over time can also be an issue, as is potential spreadsheet calculation error and missing audit trails. Businesses that automate such manual spreadsheets, for example through implementing a structured spreadsheet form or, at a more advanced level, using machine learning alongside more traditional data transformation and cleansing processes, can gain substantial benefits and savings. Multiple person-day manual efforts can be reduced to minutes by automation.

Navarro: Digital transformation achieves three things that can help companies: data management simplification, data accuracy and efficiency. Automated tax processes ensure that there is one single source of data that can be used for a multitude of reporting requirements, including tax compliance. It also provides a platform that will consistently process data applying a uniform set of tax policies, eliminating the need to manually verify and process data. Processed data can be set up to automatically reflect in tax records and reports. With an automated tax process, accurate raw and processed data can be extracted from the system in real time, allowing taxpayers to respond to audit in a speedy and accurate manner. Adopting technology earlier in the TP lifecycle can also prevent operational TP-based disputes – which arise when TP policies documented by taxpayers have not been implemented as intended, giving rise to non-arm’s length outcomes typically only discovered post year-end.

Riisberg: With automated technology, companies could have real-time visibility to their tax obligations and data, easily track milestones and filing deadlines, and review filings and legislative updates in one place. A streamlined and digitalised tax reporting process can provide efficiencies and visibility across the enterprise. Tax leaders need the right data at their fingertips, while tax authorities are looking for faster turnarounds and access into company’s systems. Additionally, the OECD’s BEPS transparency initiatives have significantly increased reporting requirements, placing more demand on manpower, creating larger amounts of data to be managed, and adding a gradual shift from the arm’s length standard to formulary apportionment, requiring careful monitoring of profit distribution among entities. There is no standard tax module in ERP systems, and with the accumulation of disparate legacy IT systems, regional differences in business approach and structure implementations, it is unwieldy for many organisations to implement global TP policies consistently. Furthermore, coronavirus (COVID-19) triggered a need to do more with fewer tax department resources, and a need for robust and flexible systems to respond quickly to unpredictable financial outcomes.

Chakravarty: Digitalisation can help taxpayers ensure consistency, reduce costs and errors, and achieve alignment between tax and TP positions across group entities. With increased data and businesses spread across jurisdictions, MNEs need digital transformation for data collection, reporting and data analysis, to enable taxpayers to obtain real-time data to accurately assess current positions and help take key decisions. With automatic data exchange, tax authorities can get a more holistic view of an MNE’s overall tax position, in addition to access to significant information, which can be leveraged by them during audits. To meet the demand for real-time audits and comply with various reporting requirements globally, including Pillar II and CbC reporting, MNEs need to digitalise and integrate their tax and accounting functions. MNEs must establish robust comprehensive IT and tax architecture, including tax and TP technology tools, to support current and evolving business, tax and TP compliance requirements.

FW: What essential advice would you offer to companies on applying standards across their enterprise to help meet finance, tax and regulatory requirements, and avoid costly problems?

Riisberg: It is essential in today’s environment to have systems and functions that work together: tools that help to connect the dots, can recognise a trend in the results, flag a risk or identify an opportunity. Including joint deadline trackers across all tax disciplines is also critical. In addition, it is important to ensure that treasury and all tax functions are aware of each other’s projects and that aligning on changes that affect one another can be done on a digital platform. It is critical for companies to undertake regular reviews of the intercompany pricing, tax and financing structure, and keep apprised of changing regulatory requirements. Having a trusted network of industry specific tax leaders, along with business advisers who help in taking a step back, summarise what they have observed, what opportunities are available and what new regulatory frameworks have developed, helps a company’s tax leader with this bigger picture need.

Navarro: Establishing an effective governance framework that is fully integrated and aligned with the overall operations of the business is key. A strong governance framework takes into account finance, tax and regulatory rules and allows these functions to regularly collaborate with each other’s compliance teams and affected lines of business across organisations. An effective governance framework will allow an organisation to enjoy significant benefits which may include, but are not limited to, reduction of costs associated with implementation and ongoing compliance, minimised financial, reputational, non-compliance and other risks, and heightened potential for ongoing economic success and compliance. Such a framework should be reviewed in the context of the changing tax and regulatory environment, to ensure that all functions can achieve an effective balance between value protection and value creation activities.

Phillips: Businesses should consider the potential benefits to be reaped from standardising and automating routine or repetitive processes. While exceptions will always exist, notably when required by local law, they can in many cases be just that: exceptional. This then allows these exceptions to be carved out and separately considered. The other critical component when seeking to apply defined standards across different activities is to ensure access to and maintenance of local knowledge, whether within the organisation or through external advisers. Local understanding of specific market and business conditions, and detailed understanding of specific regulatory obligations, can be essential for a business to flourish. Regulatory breaches, on the other hand, can cost substantially more than money.

Chakravarty: With new tax reforms, tax authorities globally are utilising digital solutions for gathering and analysing information. In this environment, it is imperative for taxpayers to shift to digitalisation to compile and analyse voluminous data to efficiently meet various finance, tax and regulatory requirements. Real time and accurate data can help mitigate risks and enable taxpayers to be equipped with data during audit to avoid costly litigations. Automatic collection and analysis of data can help taxpayers get real-time updates to take required corrective steps or key decisions. Technology tools play a key role in data collection and cost reduction but, more importantly, facilitate risk mitigation through real-time identification of errors and data analytics to achieve overall efficiency and enhance profitability. Thus, standardisation, centralisation and digitalisation are the three cornerstones for setting up an efficient internal framework to meet the ever-evolving finance, tax and regulatory requirements facing MNE groups today.

FW: What role can outsourcing play in the modern tax and TP function?

Chakravarty: With fast-paced global reforms in tax and TP, MNEs are facing difficulties in managing compliance as new regulations bring in varied processes and requirements. Outsourcing can help MNEs to manage their tax and TP function more efficiently. With outsourcing, taxpayers can rely on advisers to manage documentation and ensure compliance with the latest requirements, in line with industry standards. An adviser with specialised knowledge will be aware of possible issues or risks based on the taxpayer’s facts. Advisers are equipped with state-of-the-art tools and technical expertise, which are specially designed to enhance efficiency and mitigate risks and are typically available at minimal cost compared to in-house development. Outsourcing also provides the flexibility to free up internal resources to focus on non-routine and strategic areas of business expansion and growth. Outsourcing is a key strategic decision for MNEs, which can help them enhance efficiency and reduce errors, while increasing focus on core business functions.

Navarro: Outsourcing provides a systematic approach to tackling MNE’s tax obligations. Through outsourcing, resources with appropriate skill sets, capabilities and expertise, which are critical to the execution of tax and TP functions, are readily available. In a landscape where new regulations are introduced with unprecedented frequency, the effort required to separately comply with and respond to each requirement can put increased pressure on MNEs’ stretched resources. This may impede existing controls and procedures and impact the overall operations of the business. MNEs need an efficient, flexible, cost-effective approach to implementing required controls and processes and ensuring ongoing, timely compliance. This may be achieved through outsourcing.

Riisberg: There is a broad continuum of operating models that tax and TP functions may contemplate that involve outsourcing certain elements or entire tax functions. Many tax leaders are turning to redefining the core tax team’s primary role in the business, and this may mean shifting increasing amounts of compliance work to shared services teams or outsourcing providers that have invested in best-in-class technology and delivery centres. No matter the scale, outsourcing can alleviate issues in operations – by reducing costs and maintaining quality, in technology – by providing access to leading-edge solutions that drive value through data and streamline compliance, and through talent – by accessing leading specialists, loan staff and alleviating resource constraints. Outsourcing can help tax departments more efficiently meet statutory reporting requirements, maintain internal tax control, improve audit lifecycle management, standardise data collection, improve overall tax compliance, and often reduce audit costs. In many cases, outsourcing can provide deeper coordination and synergies across the tax function, and connectivity across a company’s tax lifecycle.

Phillips: Outsourcing can play a number of roles in supporting a tax department. This could be either the traditional role of smoothing out workload peaks and bringing in specific technical knowledge, or alternatively the full outsourcing of a specific tax function. Both models have existed in varying form for many years. With any significant tax change, groups may wish to reassess their approach to outsourcing and determine whether it is still fit for purpose. For example, groups may be able to benefit from the potentially wider experience of outsourced support in respect of new compliance requirements. A specific example of this might relate to outsource providers supporting tax departments with analysing their tax data. This could involve data transformation or evaluation and may be a specific area where the outsourced model could yield substantial benefits versus performing such a specialised activity in-house.

FW: Do you expect the pressures and challenges placed on corporate tax functions to intensify in the years ahead? What issues and trends do you expect to dominate this space?

Phillips: Pressure and challenge have always existed for corporate tax functions. This is not going to change and the requirement to ‘do more with less’ will continue. To meet this challenge, tax professionals may need to become even more data fluent. Corporate tax has always had a data component. But the data volume, variety and velocity tax functions are expected to handle is increasing exponentially – as are tax authority expectations and their access to business data. The role of the tax function will continue to involve adding value but equally defending value by ensuring tax policies are accurately documented, implemented and monitored.

Navarro: With changes to the international tax framework and demands for more digital products, corporations are forced to undertake business model transformation. These transformations will exert pressure on corporate tax functions to understand the impact of the new international tax framework and its interplay with the digital business model. It will require knowledge, if not expertise, of digital business models, supply chain restructuring and sustainability. Moreover, the new international tax framework will demand centralised resources to monitor global compliance. Hence, corporate tax functions will either outsource to third party service providers or find a technology that can deliver compliance efficiently. This will allow the corporate tax functions to free up time to perform more value-adding advisory work.

Riisberg: Many pressures and challenges that corporate tax functions have faced historically have been accelerated and intensified by COVID-19 and other factors currently impacting the global economy. For example, there is increased pressure on supply chains to be proactive instead of reactive, resulting in supply chain reinvention, lack of internal resources which intensifies the need for outsourcing and an increase in hybrid workplace use, which may create issues for many MNEs. These challenges are likely to continue and possibly increase in the coming years. As regulations get more granular, tax authorities may increase their collaboration across jurisdictions, leading to more joint audits. Information needs will increase as automated intelligence becomes more conventionally used in tax authority reviews. Mandatory environmental, social and governance (ESG) reporting is developing and EU public CbC reporting requirements in the next two years will draw attention to the tax behaviour of many taxpayers. Additionally, the way large MNEs are handling their tax matters is often highlighted in news headlines, creating increasing interest in the profile of an MNE. In essence, a company’s tax policy has become a reflection on its broader social responsibility.

Chakravarty: With globalisation and digitalisation, increased tax and TP audits are expected worldwide. This will involve detailed information requests and may result in more adjustments and penalties, and an increased level of unresolved disputes. Whenever tax reforms are introduced, taxpayers are faced with a new set of challenges. With CbC reporting and master file reporting, taxpayers initially faced challenges in data collation and consistent data reporting. Now with the three-tier documentation being accessible to tax authorities worldwide, tax authorities will leverage the entire expanse of available information to prepare for detailed audits. Similarly, with Pillar I and II regulations scheduled to be implemented next year, taxpayers will face new challenges, such as data reconciliation, taxable income calculations and adjustments. Therefore, it is imperative for MNEs to be proactive and revisit their internal digital framework to pre-empt requirements and take steps to be prepared in advance.

Kristine Riisberg is a principal in Deloitte New York. She has over 20 years of transfer pricing (TP) and international tax experience with Deloitte. She is the US TP clients & markets leader and Deloitte’s global/US TP Operate leader. She has extensive experience leading global TP compliance projects for large multinationals and has worked with clients on financial and quantitative research analysis, value chain optimisation and cost-sharing studies in a wide range of industries. She can be contacted on +1 (212) 436 7917 or by email: kriisberg@deloitte.com.

James Phillips is a transfer pricing (TP) director based in London and is the co-lead for Deloitte’s operational TP practice in the UK. He has more than 17 years’ experience working in international tax, of which more than 14 have been specifically in TP. His career has been evenly split between time spent in practice and in industry and geographically between the UK, France and Switzerland. He can be contacted on +44 (0)20 7007 7296 or by email: jdphillips@deloitte.co.uk.

Anis Chakravarty is a partner with Deloitte India, with 24 years of experience advising companies in the EU, India and the US on several issues related to finance, economics and transfer pricing (TP). He leads Deloitte’s Global TP Centre and is currently responsible for Deloitte India’s financial services TP practice. He has led large cross-border due diligences, helped multinationals realign and optimise their global supply chain and intellectual property structures, and implemented efficient repatriation strategies. He can be contacted on +91 22 6185 4265 or by email: anchakravarty@deloitte.com.

Carlo Navarro is currently Deloitte’s Southeast Asia transfer pricing (TP) leader. He specialises in TP, international corporate restructuring and planning, cross-border taxation and tax effective supply chain transformations. He has over 24 years of experience assisting clients from diverse industries, such as power, mining, telecommunications, financial services, manufacturing, distribution and business process outsourcing, in various phases of TP engagements, from planning and documentation to audit defence and negotiating APAs and MAPs. He can be contacted on +63 2 8 581 9035 or by email: canavarro@deloitte.com.

© Financier Worldwide

THE PANELLISTS

Kristine Riisberg

James Phillips

Anis Chakravarty

Carlo Navarro

Deloitte