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When Foreign Tax Settlements Have Unexpected Consequences
Certain tax and transfer pricing agreements made with a foreign taxing authority can have unforeseen and negative consequences on both the foreign subsidiary and the US parent's tax posture. Taxand US gives its take on unexpected consequences of foreign tax settlements.
Take for example, an Australian subsidiary of a US firm where the Australian Taxation Office agrees to disallow prior year losses where they are not reflected as a transfer pricing adjustment, no adjustment is made to the foreign entity's E&P for US tax purposes to reflect the fact that the Australian subsidiary could no longer access its prior losses. As a result, the subsidiary continues to reflect a cumulative deficit in its E&P account as a result of the prior losses for US tax purposes. This one-sided adjustment is not reflective of the intercompany accounting and global transfer pricing. This type of result yields unforeseen and potentially costly income tax results when earnings are repatriated back to the US.
Settlements reached with foreign taxing authorities can take various shapes and are determined largely by the income tax audit and subsequent negotiations between the taxpayer and the taxing authority. In cases where intercompany pricing adjustments are made as a result of an audit, but are not recorded as transfer pricing adjustments subject to competent authority, anomalies can occur between the amount of earnings reflected in a foreign entity and the real-life facts. Unilateral agreements with the foreign taxing authority are not globally reflective of the transfer pricing between related parties.
To ensure that Foreign Tax Settlements are dealt with comprehensively; it is important when undergoing audits in foreign taxing jurisdictions, to keep an eye on the ultimate settlement with the taxing authority as this is critical to the overall management of a company's global tax posture. In particular, agreements that have the effect of altering a foreign entity's earnings while closing off competent authority pathways must be subject to a high level of scrutiny before being finalised.
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