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Multinationals take note: don't trip into a transfer pricing pitfall

USA

Recent headlines addressing transfer pricing (Starbucks, Google, Apple) have prompted global tax authorities and regulators to be on high alert regarding intercompany transactions. Taxand USA discusses why transfer pricing remains an easy target for tax authorities seeking to increase tax revenue through adjustments and penalties. 

Most public multinational companies provide some form of stock compensation to their executives and employees. Under ASC 718, compensation costs for such equity grants are generally determined upfront and then expensed ratably over the vesting periods. Naturally, the amount expensed must be tax-affected. Many jurisdictions do not allow a tax deduction for equity compensation until the vesting or exercise dates. This difference in time (ie expense now, deduct later) results in deferred tax asset accounts. When accounting for these deferred taxes, the accountants need to know if and where a deduction will ultimately become available for the stock compensation. This is not always easy to determine.
 
A simple example involves a parent company in Country A granting stock to an employee of a Country B subsidiary. Depending on the tax rules of Country B, this basic arrangement on its own probably does not result in a tax benefit. The rationale is that the Country A company is not entitled to a deduction because it is bearing a cost on behalf of another company, and the Country B subsidiary is also not entitled to a deduction because it has not made an outlay. Certain jurisdictions have special rules that allow the employer a deduction even without an outlay (eg US and UK). In other countries it is possible to put in place intercompany agreements that compel the subsidiary to reimburse the parent, thereby creating an outlay to justify a deduction. Of course, there are often further complicating requirements in some jurisdictions, for example the required use of treasury shares by the parent company to secure a deduction.

Many companies have already sorted out this type of fact pattern and the resultant ASC 718 accounting. But this next example probably raises less recognised issues.
 
Assume instead that the same parent company grants stock to one of its own employees. This particular employee performs services that are ultimately cross-charged to a Country B subsidiary (eg cost-sharing or centralised service function). If the cross-border charge is based on the cost of the employee, a natural question is whether to include the cost of his/her equity compensation in the charge. Under recent transfer pricing guidance, equity compensation must be included in the calculation of services costs (eg management fees, cost sharing, centralised services etc). That leaves the accountants with an open question: if the equity compensation relating to an employee of the Country A company will ultimately be charged to a Country B subsidiary, should the ASC 718 tax effect be based on the value of the deduction in Country A or Country B?

Equity arrangements used by multinational corporations are subject to scrutiny by tax authorities to ensure that costs associated with these programmes satisfy transfer pricing regulations. Therefore, it is important for multinational corporations to review their current compensation policies to make sure they do not become an easy target for transfer pricing adjustments related to equity arrangements.

Discover more: Don't be an easy target, think about your equity arrangements


Your Taxand contact for further queries is:
Brian Cumberland
T. +1 214 438 1013
E. bcumberland@alvarezandmarsal.com

Also published in Thomson Reuters' Taxnet Pro, 17 October 2013

Taxand's Take

Best practices require periodic examination of equity compensation entries under ASC 718, so it is important to review services charges for proper inclusion of equity compensation. 
 
Multinationals should:

  • Take a comprehensive approach by bringing all involved professionals to the table for a discussion (eg transfer pricing, accounting, ASC 718 specialist, internal tax etc)
  • Scrutinise the company's transfer pricing and international tax structuring to understand their current position
  • When choosing an equity compensation methodology, consider other factors which may affect the company's profile, such as cash needs, ease of administration or exposure to FIN 48 (Financial Accounting Standards Board Interpretation No. 48)

 By getting in front of these issues and setting company policy for charge-outs, corporations can increase shareholder value, improve control over their tax accounting and minimise their risk of being the next transfer pricing headline.

Taxand's Take Author