TP Arrangements Resilient to Shock of US Tax Reform

Author: Josh White

The Tax Cuts and Jobs Act (TCJA) has changed a lot about US tax law, yet TP directors may have more certainty about the future than their counterparts in corporate tax.

When the TCJA first came into force, many TP professionals thought the reform process might make the landscape of transfer pricing completely unrecognisable. For most companies, though, this hasn’t turned out to be the case.

TP Week spoke to Nancy Manzano, senior tax director at Vertex, who previously worked for a Fortune 500 bank. “I’ve heard people say that because we’ve got US tax reform, and we’ve moved to a hybrid territorial regime, the significance of transfer pricing has been greatly diminished. That couldn’t be further from the truth,” she said.

TP directors expected US tax reform to have a major impact on transfer pricing, particularly when it comes to controlled foreign companies (CFCs), compliance management, disputes and restructuring. But there was one area where they feared a fundamental shift.

“If US tax reform is successful, it will have a significant impact on global taxing rights and the future of the ALP [arm’s-length principle],” one tax director at a multinational company told TP Week.

The ALP has long been a keystone of transfer pricing, but there are growing concerns that the international tax system is moving away from the principle. But others suggest this is overstated.

“It would take something far more drastic than US tax reform to change this,” Manzano said. “Dare I say that formulary apportionment would be that change.”

“It would be a completely drastic change to how you tax profits across the globe and tax reform did not take us to formulary apportionment,” she added. At the same time, businesses are wary of overhauling past arrangements too quickly. This isn’t to say there’s been no change. Although the tax cuts have provided an opportunity for massive buybacks and have given a boost to capital expenditure (capex).

"One of the most important features of the tax reform is the immediate expensing provisions. Expensing the capital purchases is one of the factors behind the construction boom we’re seeing,” said Stephen Moore, Heritage Foundation economist. “Everywhere you look you can see cranes building.”

However, the change in rates and write-offs are much less significant when it comes to transfer pricing. As Mike Bernard, chief tax officer at Vertex and former tax director at a major tech multinational, told TP Week: “The fact that the corporate rates have flattened out doesn’t change the reality that each jurisdiction is entitled to the proper amount of tax according to traditional transfer pricing norms.”

Manzano added: “Companies are still going to have to structure their operations to make the most business sense and reduce tax risk as much as possible.”

No business case for major changes

Most US companies have updated their TP practices over the past five to seven years. Some businesses have moved sales functions out of regional operations centres to the local sales subsidiaries using a limited risk distribution model. This movement places greater functional activities at the local country level.

“Unless companies have made changes to their supply chains, US tax reform wouldn’t immediately affect their transfer pricing,” Manzano stressed. “Tax law doesn’t always change the underlying economics.”

Without these changes companies are going to make a very concerted effort to document their TP policies and the value of their functions in the given jurisdictions.

“Companies have invested heavily over the past 20 years to place their sales and support functions in jurisdictions which best serve their customers,” Bernard said. “They are not just going to shift those operations overnight. Any restructuring will always emphasise cost, efficiency and best serving their customer.”

“Any movement will have to suit the business model of the company in question,” he explained. “I don’t see US companies moving out of a country such as Ireland because the workforce and business environment is excellent.” “Very few companies are going to let the tax tail wag the business dog,” Manzano added.

Putting economics first

One of the big hopes for tax reform is that it would make it more attractive to bring intellectual property (IP) assets back to the US. There has been some movement on repatriating cash assets by certain companies, including Apple, though there are still many advantages to offshoring IP.

“When we talk about IP, there is the first issue of legal protection and then there are the economic aspects of IP and where that value is utilised,” Bernard said.

“When it comes to business profits, IP is going to be utilised in various jurisdictions – which country is entitled to the profit of that IP will be determined based on the value of the entire business chain and where those functions are centred,” he added.

Most US multinationals are going to keep their IP under US protection because that is the best option from a legal perspective, he explained. When it comes to European companies, many businesses choose the UK or Ireland. This is less true of American corporations, though these organisations are more than happy to locate their intangibles in Europe.

“A lot of companies transferred intangible assets to foreign affiliates and licensed the intangibles from those affiliates,” Wall Street tax adviser Robert Willens said. “This shifted income from the US parent company to a foreign affiliate, which owned the intellectual property (IP).”

“European countries tend to tax IP at incredibly low rates. Sometimes as low as 5% in places like the Netherlands, Ireland and the UK,” he stressed. “Now some of that foreign income will be taxable in the US under the GILTI rules and the BEAT.”

Meanwhile, there are concerns over what the TCJA will mean for the economy in years to come. Businesses may experience a short-term boost at the expense of long-term stability.

Economist Charles Lieberman, who has worked for such banks as Morgan Stanley, Lehman Brothers and JP Morgan Chase, raised concerns over the long-term problem of US debt.

“There is also the long-term question of US debt and the growing deficit, but there’s no indication that the market is overly saturated with US debt right now,” he observed. “In fact, there may still be tremendous appetite for US sovereign debt. But the path we’re on is not really sustainable in the long-term.”

This is precisely why many taxpayers are playing the waiting game. The future of US tax policy is anything but certain and, although tax reform has opened the gates to bring cash and other assets home, the pace of change may mean more companies are likely to take their time.

Originally published in International Tax Review and TP Week.