Intercompany accounting—the management of financial transactions between separate legal entities that belong to the same corporate group—has been cast into the global spotlight and thrust under a multinational microscope. As governments re-examine tax policy, new tax and accounting regulations and expectations make it increasingly challenging to manage tax leakage and comply.
To overcome these challenges, we need to understand why intercompany accounting has increasingly become a target for scrutiny.
Identifying Key Developments
Before the 2008 financial crisis, global tax developments happened at a snail’s pace. They were so sluggish that few efforts made it past the starting line. People and politicians simply lost interest. If it wasn’t for the collapse that followed shortly afterward, things might have stayed that way for a long time.
Suddenly, many large banks and companies needed to be shored up and kept in place by governments. This inspired a movement decrying the fact that many big businesses were not paying their fair share of corporate income taxes. Investigations were launched, problems identified, and various remedies were implemented—many directly related to intercompany financial management and associated tax strategies.
Key development #1: Foreign governments began working together. New coordination efforts introduced new anti-tax haven rules. The Anti-Tax Avoidance Directive (ATAD I and II) was proposed and adopted by the EU in less than six months. The 25% U.K. diverted profit tax was introduced in April 2015. The anti-hybrid and base erosion and anti-abuse tax (BEAT) rules were introduced in the U.S. along with the global intangible low-taxed income (GILTI) rule, perhaps indicating a shift closer toward morality rather than mere legality.
Key Development #2: Tax authorities began making automation a requirement. Motivated by fraud and anti-fraud measures, more and more countries, especially those considered “developing countries,” have started turning their attention to the tax planning process and demanding real-time reporting and e-compliance, most notably for indirect (i.e. transactional) taxes.
Key Development #3: Multinational groups are expected to provide more transparency. Many countries now demand to see what multinationals are paying in other parts of the world. The general public, too, wants to see where and how much multinationals are paying in tax globally. The EU’s DAC6 imposes mandatory reporting of cross-border arrangements. OECD countries, including the U.S., now require multinational enterprises (MNEs) to provide country-by-country reporting on their profits, headcount, and taxes paid.
Key Development #4: International tax rules are being revised in line with the digitalization of the economy. Pillar One of the proposals put forward by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) seeks to ensure that the allocation of taxing rights on business profits is no longer exclusively determined by reference to physical presence. Pillar Two aims to ensure that large internationally operating businesses pay a minimum level of tax regardless of where they are headquartered or the jurisdictions in which they operate. Based on President Joe Biden’s recent calls to increase the U.S. tax rate on global intangible low-taxed income to 15%, it appears that this is what the U.S. expects the global minimum tax rate to be.
Highlighting the Outcomes
To better understand the full impact of these developments on intercompany financing, let’s briefly explore a few high-profile examples.
The first business case study of note involves Bristol Myers Squibb. In an effort to substantially reduce its U.S. tax bill, the U.S. pharmaceutical company decided to move its profits through a specially created subsidiary in Ireland. Years later, after an accidental exposure revealed the arrangement, the IRS concluded that Bristol Myers was underpaying U.S. taxes of approximately $1.4 billion. The current status of this tax dispute is not clear. It is likely to spend years winding through the IRS appeals process before any settlement is reached.
The four key developments mentioned above also played a big part in the U.S. tax overhaul of 2017. This was when the BEAT was introduced to reduce the channeling of U.S.-generated profits to lower tax jurisdictions. The BEAT targets large U.S. multinationals that make deductible payments, aka base erosion payments, such as interest, royalties, and certain service payments, to related foreign parties. It is a minimum tax add-on, and base erosion tax benefits are determined by reference to base erosion payments. As you can imagine, BEAT reporting requires granular transaction-level details.
The IRS also feels significantly short-changed by dozens of big, profitable companies. Just as the Biden administration is pushing to raise corporate tax, a new study by the Institute on Taxation and Economic Policy found that at least 55 American giants paid zero corporate income tax last year, despite raking in billions in profits. However, a global tax deal is going to be hard to achieve. Under EU law, tax generally remains a matter for national governments, who would have to agree unanimously on a minimum corporate tax. While the average EU corporate tax is 21.7%, some countries, like Ireland, tax well below (12.5%).
Many U.S.-based digital service providers like Netflix, Spotify, and Snapchat, have come out against any global digital services tax proposed by Pillar One of the OECD/G20 Inclusive Framework mentioned above. The companies are instead recommending a solution that simply taxes profits rather than revenue. This highlights the complexities resulting from the “go at it alone” approach to digital services tax and the inherent double taxation consequences.
Facing the Fallout
In a bustling and quickly changing landscape, it stands to reason that intercompany accounting is becoming more and more complex. The general expectation is that related processes and technologies must drive greater granularity and transparency. Gone are the days when headquarters could simply charge a management fee, or intercompany service charge, to countries that are being managed. Today, multinationals must specify what the management fee consists of and how it benefits their managed entities. They also have to be transparent about each cost and explain the benefit received in exchange for those costs.
In light of the new public and customer expectations for corporate responsibility, the morality of aggressive tax planning is also being brought into question. Multinationals like Royal Dutch Shell and Unilever are honoring the calls for transparency by self-publishing their aforementioned country-by-country reporting.
Long-term trends also indicate that corporate income tax rates are decreasing globally. At the same time, indirect taxes like value-added tax (VAT) and payroll tax, have become significant contributors to treasuries—especially in Europe. Multinational companies need to keep a close eye on changes to the VAT and transactional tax policies of the countries they do business in. For many countries, most notably the smaller ones, indirect taxes (like those placed on intercompany transactions) are becoming a major source of revenue.
The new complex reality created by all these developments impacts not just the corporate tax department, but specifically intercompany accounting and intercompany tax. Multinationals must constantly find new ways to allocate their cross-border profits company-wide, in a fully transparent, margin-friendly way while keeping compliant.
Multinationals wanting to reduce risk, lower the financial impact of non-compliance, and improve productivity, need to reassess how their tax teams operate. Team mission statements must evolve from “minimizing taxes in every legal way possible” to one that focuses on intent and appropriateness. The nature of tax teams must evolve, too. They need to become more involved in the corporate decision-making process. They must meet rising regulatory demands for data consistency, transparency, and accuracy by shifting their focus from complex financing structures to operating processes.
For the intercompany accounting function, this requires radical advancement. Companies need to stay on top of intercompany agreements. They need to automate tax processes and be able to provide real-time reporting and e-compliance. And, finally, they need to quickly adapt to new developments brought about by the digitalization of the economy.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Dirk van Unnik is Vice President of Tax Development at FourQ (www.FourQ.com). Built by finance, accounting, and tax experts, FourQ deploys Intercompany Financial Management (IFM) software that streamlines the IT operations of the world’s largest companies.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.