Authors: Steef Huibregtse is CEO and Senior Partner and Maria Grigoryeva is Junior Associate at TPA Global.
Following BEPS publication on profit split on October 5, 2015 and July 4, 2016, MNEs are being challenged to apply the holistic view on their value chain. This article suggests a practical and quantitative approach on how to ‘slice the pie’ and allocate the profit margin within a MNE.
Transfer pricing methods have allowed MNEs to determine the intercompany compensation to each group entity by looking at the functions performed, risk assumed and assets employed without taking the holistic view of how the 100 percent margin should be allocated. BEPS publications have detected that this approach does sometimes give an unbalanced outcome in how profit is allocated. Situations which might be labelled as unbalanced in a BEPS context include:
one-sided benchmarks: For example, by providing a routine function a modest and relatively fixed operating margin, it assumes any residual would land in one or more of the other group entities. Whether such one-sided approach leads to a balanced allocation of profits can be disputed.
- intangibles structures without ‘‘people functions’’: For example, by having Bermuda or Malta as legal owner of a brand claiming a royalty from all other group companies, while no active value creation happens in Bermuda or Malta will be challenged by tax authorities.
- Commissionaires’ structures with ‘‘significant people functions’’: For example, the BEPS reports and the OECD Model Convention have put a spell on the use of commissionaires, since tax authorities have seen this legal concept being used to repatriate profits—through transfer pricing—to the principal entrepreneur in an MNEs structure. Mostly the challenge has been that some of the principal functions are being performed by the ‘‘people functions’’ on the commissionaires’ payroll. Rather than disqualifying the legal concept of commissionaire, the OECD should have indicated that the ‘‘commissionaire performing principal functions’’ is the real problem.
- geographically fragmented ‘‘people functions’’ involved in intangibles management and risk management: For example, a pharmaceutical is running the 24 FTEs R&D department in a virtual manner, i.e. all board meetings are registered in Ireland, while all R&D ‘‘people functions’’ are working from different locations. The question is whether BEPS reports support a consistent interpretation of whether Ireland can claim the full benefits of ‘‘managing the registrations of intangibles’’?
- entities owning intangibles without absorbing related cost: For example, a department of R&D professionals is developing, maintaining and exploiting a portfolio of technical patents. However, all cost are on-charged as part of the headquarter charges to all the production group entities.Would the local tax inspector where the R&D professionals are located be able under BEPS reports to claim a higher compensation for their activities, while no net cost have been incurred by that department over the last five years.
The above examples are a mere selection of many pending discussions with corporates on their business configurations being ‘‘BEPS ready.’
Read the complete VCA document