Tax Compliance Toughens for Intercompany Transactions
From: CFO, May 23, 2017
As the new administration’s trade policies come into clearer focus, it is obvious that some changes are underway. Actions by the Trump administration could redirect trade flows and incite an all-out trade war. Retaliatory actions by foreign countries could alter the regulatory landscape, leading to a confusing array of new regulations with complicated tax and accounting obligations.
Many global businesses already strain to comply with complex rules governing cross-border intercompany transactions. Finance and accounting personnel must cope with local tax policies, currencies, and transfer pricing, as well as evolving global mandates requiring greater transparency and controls. If intercompany transactions are not accurately reconciled and eliminated, the out-of-balance accounts can have an adverse impact on the financial statements. Compelled to issue a restatement, the organization may incur steep SEC fines, a rash of shareholder lawsuits, and lingering reputational damage.
Rules in Flux
Many U.S. companies are still making the internal process changes needed to comply with BEPS (Base Erosion and Profit Shifting), developed by the OECD (Organization for Economic Cooperation and Development). They’re doing much of the same with respect to two evolving IRS rules, Sections 385 and 956.
The OECD launched BEPS in 2013 as a project to enable automatic sharing of company tax information on a country-by-country basis. The final report was issued in December 2016 and subsequently signed by 31 countries. The signatories are now in the process of taking steps to ratify the agreement according to local laws.
A key tenet of BEPS (Action 13) is to enhance the transparency of multinational enterprises’ business operations to make it easier for global tax administrations to conduct transfer-pricing risk assessments. These evaluations are needed to combat the rise in corporate tax avoidance strategies, whereby profits are shifted from jurisdictions with high taxes to those that have little or no taxes.
Compliance with BEPS requires businesses to capture and roll up the data points involving an intercompany transaction between two associated companies that file a consolidated tax return or financial statement. Information on the flow of capital from a parent to a subsidiary, a subsidiary to a parent, or a subsidiary to a subsidiary must be reported and filed in all relevant jurisdictions.
Compliance with BEPS is extremely challenging for finance and accounting personnel. To document, reconcile, net, and settle tens of thousands of intercompany transactions requires manually sifting through multiple, disconnected ERP and general ledger systems and applications. When questions arise, the staff relies on spreadsheets, phone calls, emails, and attachments to ensure proper, accurate, and documentable records for compliance purposes. Small wonder that 25% of companies expect to miss the BEPS deadline of Dec. 31, 2017.
Equally problematic are Sections 385 and 956 of the Internal Revenue Code. Section 956 (Subpart F) allows a controlled foreign corporation (CFC) of a U.S. multinational company to loan its earnings to the parent for use in paying dividends on a tax-deferred basis. Taxation occurs if the parent attempts to use the CFC’s earnings prior to paying a dividend.
In 2015, the rule was changed to provide a 30-day exception for short-term loans. If the loan is repaid within 30 days from the time it is incurred, the tax remains deferred. However the exception applies only if the CFC does not hold any debt obligations of the related entity for 60 days or more within the taxable year. If it exceeds this 60-day limit, the 30-day exception does not apply.
The new rule creates worrisome timing challenges. Finance and accounting personnel must be fully aware of the outstanding debt obligations and the associated aging of the debt. Tracking this activity via spreadsheets, emails, and phone calls is a substandard way to maintain compliance.
Section 385, which addresses the use of cross-border debt to reduce U.S. income for tax purposes, poses other administrative demands. In 2016, the rule was amended to allow the IRS to treat certain third-party debts as indebtedness in part, and as stock in part. Previously, the transaction was treated either as wholly stock or wholly debt.
Going forward, a company must document the commercial terms of the lending to receive IRS acknowledgement of the intercompany transaction as debt (and not equity). Otherwise, the “debt” cannot be treated as such for federal income tax purposes.
Companies can expect further compliance strains requiring added due diligence. To address growing intercompany documentation responsibilities, the associated tasks must be automated. Intercompany agreements can then be stored in a centralized database, affording clear visibility into the underlying details of each.
As the new administration takes steps that alter the global trade landscape, manually attending to the resulting changes in tax and accounting regulations is no way to maintain compliance.