Sting in the tail of change programs that forget about tax
Contract managers, do you know that international tax law changes will put organizational structures to the test as never before? Read on.
Huge global change programs being rolled out to pave the way for imminent international tax law changes will put organizational structures to the test as never before. Will yours be one that pays the price? Or will you, as a contract manager, be the one person who can save the day?
Big changes in international tax law are around the corner to ensure profits stay in the country that generated them. But as multinationals put their change programs in place to prepare for the Organisation for Economic Co-operation and Development (OECD) reforms 1 they may be unaware of silos and gaps in communication that could expose them to big tax risks.
In the recent Deloitte survey on the impact of the OECD reforms,2 75% of respondents agree or strongly agree that double taxation will occur as a result of unilateral tax law changes being made in anticipation of the OECD recommendations – and there will be greater scrutiny. As a contract manager or specialist you may be the only person within your organization whose cross-functional role has visibility of oversights that could have big tax implications down the line.
Company silos may spell trouble
Corporations operating across multiple jurisdictions have been busy putting procedures, policies and appropriate people in place as they respond to these preliminary national tax law changes now underway to prepare for the OECD reforms.
But in complex organizations, where separate functions are likely to be delivering different aspects of the change program, it is all too easy to miss important aspects, especially if a recent reorganization or merger has occurred. In a scenario of this complexity gaps may occur in specific knowledge or awareness that only the cross-functional perspective of a contract manager can identify – as the case study below shows.
Inter or intra-company: transfer pricing is easily overlooked
Transfer pricing principles are central to the OECD3 aim of ensuring that taxable profits of multinational enterprises are not artificially shifted out of their jurisdiction4. But they are easy to overlook when addressing the difficult contracting issues that arise when creating agreements between legal entities within the same enterprise (intercompany agreements) or between two or more entities within the same legal entity (intra-company agreements).
In simple terms, transfer pricing concerns transactions such as the provision of goods, services or intangibles between separate legal entities within associated enterprises, or their overseas branches or subsidiaries. If the recipients would otherwise have had to perform the services themselves, or outsource to a third party, they must be charged for the services (the arm’s length principle).
When legal entities within the same capital group are providing services to one another, legal and transfer pricing issues can become extremely complex, especially if offshoring centres are involved. “Shared services” could occur among head office, branches and subsidiaries, and newly acquired businesses that may not be part of the shared services function.
Transfer pricing adjustments may trigger further implications, such as a withholding tax, if it turns out there was overpayment or undercharging, not to mention lack of a specific agreement covering such transactions. Your unexpected tax bill could climb still higher with tax geared penalties.
Cross-organizational v cross functional - case study shows the risks
This case study illustrates what happened when a major corporation acquired a global company with offshoring centers that were providing services for multiple branches and subsidiaries.
Each company put a massive change program in place to deal with its own, specific regulatory requirements, such as data protection, bank secrecy, tax and transfer pricing. But each was focused on either the legal or the tax side of the project – with no opportunity to view the issues in a holistic way.
Strong support from a number of cross organizational functions alone was not enough to identify significant issues that a contract specialist’s cross-functional perspective could have avoided. These included:
- Potential double taxation of the same profits, once in each territory associated with the transaction;
- Double VAT in certain scenarios;
- Imposition of tax geared penalties (typically up to 100% of the tax arising on any transfer pricing adjustment made);
- Interest on tax paid late as a result of a transfer pricing adjustment;
- Management and statutory accounting issues related to reporting;
- Greater issues later in addressing the transfer of post-merger agreements.
The two-track approach also risked duplication, delays and inefficiencies including:
- Added complexity in the processes of approvals, governance, and contract review;
- Uncertainty for users on which agreements should be signed (e.g. just legal, tax or both at the same time, and who should make that decision).
- Duplication of work on inter/intra company contracts;
- Double the number of documents held in the repository;
- Less efficient addressing of regulatory and compliance concerns, causing compliance, regulatory and standardization issues later;
- Decentralized metrics, policies and subject matter expertise.
Contract Management intervention brings scopes together
In this case, thanks to the involvement of contracting and subject matter experts directly impacted by the transfer pricing arrangements, the two projects were brought together, with enough time to:
- Identify commonalities;
- Set project boundaries to ensure no overlap of scope;
- Agree on the approach to address legal and fiscal requirements in a set of contract templates;
- Start work on a common repository and improved governance.
Bringing the two project scopes together addressed or completely mitigated potential risks, and the work became much more effective:
- Agreements were matched with the actual charges, while also addressing the purely legal requirements;
- Various group policies and regulatory requirements could be addressed at once; and
- Important links were established for future roll-outs of post-merger projects.
In a constantly changing business world with mergers, acquisitions and work moving cross border, it’s vital that project management teams include people involved in contracting within the same capital group, to minimize regulatory and financial risk.
Contract and transfer pricing subject matter experts and project managers should keep their eyes and ears open, collating information that will enable them to react and exchange information with appropriate people. And even if you are not directly involved in risk mitigation on transfer pricing, you can be the eyes and ears of other functions within your organization.
For this reason it’s important to maintain relationships across the various business functions so you can see the big picture and understand the implications of information you may receive. Always stay vigilant, challenging positions and approaches, and using your insights in a creative way, communicating issues early so that business around you is more robust, flexible and compliant.
- Organisation for Economic Co-operation and Development (OECD) reforms are aimed at tackling tax avoidance by ensuring profits are taxed in the countries where the value is created and profits generated http://www.oecd.org/ctp/beps.htm
- OECD’s BEPS initiative – second annual survey: key findings (see below) http://www2.deloitte.com/global/en/pages/tax/articles/beps-global-survey.html
This article originally appeared in Contracting Excellence magazine on 02 Feb 2016 view edition