Intercompany service charges, particularly headquarters or management services (referred to herein as “HQ services”), are one of the most common transactions for multinationals, but also can be one of the most difficult to successfully defend. Benchmarking an arm’s length cost-plus mark-up for this type of intercompany transaction is usually the easy part; supporting the cost base to which the mark-up is applied is often a more difficult task.
The COVID-19 crisis has not made the latter task any easier. As financial losses mount in businesses around the world, often it seems these losses are concentrated at the HQ level. Pricing HQ services is typically a subjective exercise, and it is the easiest to adjust by tax authorities. (Tweet this!)
In this article, we will address a question some clients have asked about how to account for this kind of intercompany transaction during COVID-19: Can HQ service fees potentially be adjusted upward to facilitate operating loss dispersion among subsidiaries of multinational entities?
The ideal intercompany HQ services arrangement consists of a few key components, namely:
Given the skepticism with which tax authorities view HQ service charges from a recipient perspective, even having all of the above in place will not ensure audit safety if the charges are contested. Additional challenges often include tension between the service provider and service recipient as to the level of benefit of the services and the cost discrepancy when charging from a high-cost country to a low-cost country.
Before altering a fee arrangement for this type of intercompany transaction, accounting for a scenario like COVID-19, for example, it is best to view any potential changes through the lens of the aforementioned components. To determine whether increases for HQ services are warranted (and how they might be viewed by the tax authorities) ask the following questions:
These questions are by no means exhaustive, but if the short answer to all of these is no, then it may be difficult to support an increase in HQ service charges. As the financial situation of the service recipients becomes more uncertain, increasing charges to all recipients without sound economic reasoning will undoubtedly increase transfer pricing risk.
Any opinions expressed in this article are those of the author, and not necessarily those of Valentiam Group.