Pricing Intra-Group Services, is it only about the mark-up?
Intra-group service is one of the most common international related party transactions between multinational enterprises (“MNEs”). Today, almost all MNEs require a diverse range of services from associated enterprises whether it is administrative, technical, strategic management, financial or commercial.
Because it is a common transaction, tax authorise around the world do focus and challenge the pricing of intra-group services, especially post BEPS where the substance over form principle has been enhanced as the core for any intercompany transaction.
Why are intra-group services easily challenged by Tax Authorities?
Intra-group services are frequently challenged by tax authorities because when priced incorrectly, it is an easy target for transfer pricing adjustments. More frequent than not, taxpayers are concerned only about getting the mark-up right and often forget about addressing other key areas of pricing intra-group services such as the benefit test and the cost base.
The issue is that in a transfer pricing review and audit, Tax Authorities do ask questions about these areas and they have an expectation that all of them should be ‘ticked off’ to price intra-group services correctly.
How can taxpayers ensure that intra-group services are priced correctly?
The OECD Guidelines and Tax Authorities around the world accept as a common practice that when pricing intra-group services the following key steps should be followed:
Step 1: Determining whether the activity is chargeable by addressing the ‘benefit test.'
Step 2: Determining an appropriate service charge which involves:
- Identifying an appropriate cost base that includes only costs associated with the service provided.
- Determining an arm’s length markup for the service charge.
Although it may seem straightforward, taxpayers often overlook the importance of addressing the benefit test or analysing the cost base.
If the benefit test is missing, tax authorities can challenge the service by arguing that a service has not been provided and disregard the service charge entirely. Taxpayers struggle with providing evidence of the benefit test as it involves an element of judgment and some tax authorities can be stricter than others and request for detailed evidence such as monthly calls, orders with a formal request for the service, evidence of travel.
Similarly, an incorrect cost base can create transfer pricing risks for taxpayers; the cost base is the higher component of a service charge and if calculated incorrectly it can increase or decrease the service charge significantly. If the cost base is calculated incorrectly because it doesn’t follow the arm’s length principles, the service charge is not at arm’s length even if the markup applied is tested and within the arm’s length range.
What can taxpayers do to price intra-group service right?
A few practical tips that in our experience can assist in managing the transfer pricing risks associated with intra-group service include:
- Address the benefit test in transfer pricing documentation covering intra-group services. Whether you prepare the documentation in-house or if it is prepared by consultants, it is critical to include an analysis as to why the activities are chargeable. In practice, this is addressed by performing the benefit test which involves explaining why the activities confer a benefit to the recipient and whether a third party in a similar situation would be willing to pay for such activities.
- Ensure that an analysis of the cost base is included in the documentation providing a detailed breakdown of all the cost included and whether allocation keys were used to allocate the costs among various entities.
- Make sure that an appropriate mark-up is determined using a benchmarking analysis. The mark-up depends on the nature of the intra-group services and the risks assumed by the service provider.
- Make sure that the service charge is implemented correctly and invoices and general ledger entries are in line with the pricing policy tested in the documentation.
Remember it is all about being prepared for questions from tax authorities by anticipating what they are likely to ask and expect in the event of a transfer pricing review and audit.
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 Based Erosion and Profit Shifting