The Tax Cuts and Jobs Act, signed into law on December 22, 2017, has caused a radical change in the U.S. tax system, impacting both domestic and international organizations, as well as some individuals. Since that date, the tax implications for corporations continue to be extensively analyzed, digested and modelled to assess the impact to individual client structures.
There are transfer pricing implications that align with some of the international tax changes for businesses, in particular related to new global structuring that may take place in order to take advantage of lower U.S. tax rates and incentives to develop and keep intellectual property in the U.S. There is, however, no immediate transfer pricing consideration that will impact 2017 corporate tax return filings, like the deemed repatriation requirement for offshore liquid assets of U.S. corporations.
An amalgam of diverse considerations for corporations ensures that the transfer pricing implications will not be the same for everyone, and must be considered and modelled on a one-on-one basis with clients. Simultaneous consideration must be given to business objectives, supply chain factors, compliance requirements, global tax efficiencies, expansion planning and other factors that drive cash needs for the global business. With the individualized and longer-term transfer pricing impact still to be seen, there are some initial transfer pricing takeaways that can be gleaned from the Tax Cuts and Jobs Act.
FDII and GILTI: An Indirect Impact on Transfer Pricing
Foreign Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), among other provisions, in short, attempt to prevent the shifting of profits to foreign tax havens. FDII encourages companies to develop and keep intellectual property (IP) in the U.S., rather than migrating abroad, in an effort to maintain the higher, non-routine income derived from said IP within the U.S. FDII also effectively creates an export incentive and rewards IP holding within the U.S by establishing a reduced rate on income associated with certain exports (sales/leases of property, royalties, and services to non-U.S. parties). In a similar vein, GILTI penalizes companies by subjecting foreign income derived from IP in low tax jurisdictions to current U.S. taxation. This introduces an anti-deferral mechanism to the tax law. FDII and GILTI work in tandem so that the IP of U.S. companies (and the income associated with that IP) remains in the U.S., or is migrated back, if held overseas.
FDII and GILTI have more of an indirect impact on a corporation’s transfer pricing. Transfer pricing considerations do not go away with increased U.S. ownership of IP, though the countries of focus may be altered. Transfer pricing is not just a U.S. consideration: every major market of the world has transfer pricing regulations or guidelines, and there will still be intercompany transfers among global affiliates to test against the arm’s length standard. While IP ownership may increase in the U.S., companies still have incentives to support this IP with offshore technology development service centers in markets with low labor costs. Thus, specific tested intercompany transactions may be altered, in addition to the markets of those tested intercompany transactions, but the level of intercompany transactions – and overall need for transfer pricing analyses – will not necessarily change.
BEAT: A More Direct Impact on Transfer Pricing
Compared to FDII and GILTI, Base Erosion Anti-Abuse Tax (BEAT) arguably has a more direct transfer pricing impact, in that it involves related parties. BEAT requires applicable taxpayers to pay tax equal to base erosion minimum tax amount (BEMTA). BEAT targets payments from (to) U.S. companies to (from) related foreign parties. BEAT will generally only apply to those companies with significant related-party payments to foreign affiliates, however, the introduction and application of BEAT makes such significant related-party payments more expensive. A list of included and excluded payments per BEAT are as follows:
- Included – payments for services (subject to certain exclusions), royalties, and interest.
- Excluded – payments for Cost Of Goods Sold (COGS), payments for services tested under the Services Cost Method (SCM) (i.e., services that are more general and administrative in nature and do not contribute significantly to the fundamental success or failure of the business), and qualified derivative payments (subject to specific conditions).
An interesting and unclear feature of BEAT is the exclusion of COGS payments from base erosion payments. Many questions still remain as to what is an acceptable embedded COGS service. It can be argued that the COGS payment exclusion even incentivizes certain services to be recorded as COGS that would have not otherwise been classified as such. Additional, or more precise, reporting for intercompany transactions are anticipated. For example, the importance of method selection (e.g. asking, “Is the service SCM or not?”) as well as identification of a transaction as a service or royalty, versus embedded as part of COGS, will be subject to extra scrutiny.
As well, there are significant increases in penalties – from $10,000 to $25,000 – for failure to disclose intercompany transactions by filing Form 5472 at the time of a corporations tax return filing. This form is filed for each foreign or domestic related party with which a corporation has a reportable intercompany transaction during the tax year.
Limitations on Income Shifting Through IP Transfers
The definition of an intangible asset of Section 936(h)(3)(b) has been amended to include any goodwill, going concern value, workforce in place, and any other item in which the value or potential value is not attributable to tangible property. This codification of intangible asset prevents the inappropriate justification of transfers of value without compensation on those transfers. Moreover, Section 482 was also amended to clarify the authority of the Secretary and the Internal Revenue Service. The amended text states that IP transfers may be valued on either (i) an aggregate basis (if this is the most reliable means of valuation) or (ii) a realistic alternative basis (which observes potential profits or prices if the IP were to be transferred to an uncontrolled party).
Including goodwill, going concern value, and workforce in place as IP may make the comparable uncontrolled transaction (CUT) method less reliable as a selected transfer pricing method. The reason for this is because the complexity of a given company’s IP has been magnified as a result of the increased number of IP sources. As a consequence, it is now more likely that the nature of one company’s IP is less comparable to the nature of a tested company’s IP, and thus the CUT will not be selected as the Best Method.
The Tax Cuts and Jobs Act has certainly affected transfer pricing, and some of the immediate influences have been discussed. FDII, GILTI and BEAT interrelate with one another and it is challenging—perhaps implausible—to declare a singular impact of the new law given the variegated organizational structures and businesses of U.S. multinational enterprises. The various aspects must be modeled together and for each individual company. Just as one aspect of the Tax Cuts and Jobs Act can have a positive impact, another can have a negative one. Thus, the overall bearing of the Tax Cuts and Jobs Act is best assessed by viewing the facts and circumstances of a given organization and modeling the ultimate impact based on each client’s unique facts, circumstances and business objectives.
Insights
