Part of action point 12 of the BEPS action plan makes reference to the charge out of central costs to subsidiaries of a multinational group:
“Transparency also relates to transfer pricing and value-chain analyses.
A key issue in the administration of transfer pricing rules is the asymmetry of information between taxpayers and tax administrations. This potentially undermines the administration of the arm’s length principle and enhances opportunities for BEPS. In many countries, tax administrations have little capability of developing a “big picture” view of a taxpayer’s global value chain.
In addition, divergences between approaches to transfer pricing documentation requirements leads to significant administrative costs for businesses. In this respect, it is important that adequate information about the relevant functions performed by other members of the MNE group in respect of intra-group services and other transactions are made available to the tax administration.”
This subject has been commented on at the consultation with business at OECD and the UN committee of tax experts and some of those comments give me cause for concern. I’ll come back to why later.
Multinational groups incur what are variously known as “head office costs” or “central costs” and the issue is how much of these costs relate to stewardship (i.e. looking after the interests of the owners of the group) and how much are costs incurred centrally but for the benefit of the businesses in the group. The second type of expense is charged out to operating subsidiaries. Now MNCs spend a lot of time making sure that their costs are under control and the regular reporting in the press of cost cutting initiatives is testament to this. All these costs are incurred for business purposes; the real question is whether they are stewardship or service. MNCs put in place sophisticated systems to track and allocate these costs; they also review whether costs can effectively be incurred in lower cost locations.
This leads me to my concerns. At the October 1 OECD consultation business asked what was the concern with this type of cost? The response was there was concern about “some aggressive charge outs leading to base erosion”. Now I was puzzled by this. I’m sure there are examples of aggressive behaviour by some corporates, but I don’t recognise this as a general issue.
For some time (while I chaired the BIAC tax committee) I urged OECD to have a practical workshop on the subject of central costs between governments and business. Unfortunately that didn’t appear to be a high priority. So we are left with an old framework in deciding on the treatment of central costs.
At the UN Committee of Tax Experts the same concerns were raised by government, together with the argument that the costs were too high as the work could be done at lower cost in lower cost locations. Now this is a dangerous road to follow. As I said earlier, business doesn’t incur costs lightly and decides on what costs it will incur and where after careful analysis. The fashion for low cost outsourcing has shown both the benefits and drawbacks of an approach to primarily lower costs without attention to quality. I don’t think governments should tell business where to incur costs.
So I think that business should be concerned about the perception of governments in this area and some governments should be worried too. Let’s assume that all the costs incurred are business expenses, the question is which costs are for stewardship and which are for services and for the service expenditure how should it be allocated around the group.
If a country disallows a service charge, then there are two possible consequences, either that tax deduction should be allowed by another country (probably where the mnc is domiciled) or if this is not agreed, a genuine business expense is not deductible for tax purposes and double taxation occurs.
My worry is that the end result will be double taxation. While business is focussed on BEPS, it also must also focus on the ramifications of BEPS and the risk of double taxation, the integrity of the framework for international tax should not be underestimated, why is why the ICC project is important and needed.
What is to be done? Well I still believe that we need to revisit, update and agree the basis for the tax treatment of central costs and the dividing line between stewardship costs and service charges.