Making sure that you split the bill after an evening out with friends has been made quite easy with payment apps. However, how does this work with large multinational enterprises (MNE’s) who essentially exist because they run a centralized model? How do they charge out the costs for in-house centralized services to the benefitting group companies?
‘Centralized services’, are services performed in-house such as IT, HR, HSE, Legal, Finance, Tax and of course The Board. MNE’s internalize these ‘centralized services’ for consistency, cost-efficiency and control purposes (from a strategic perspective you may not wish to be dependent on a third-party).
Tax authorities frequently challenge charge-outs for centralized services. Since these ‘management fees’ are not always properly substantiated and are thought to be a tool to reallocate profits to headquarters. As part of the OECD BEPS initiative, intra-group services have been scrutinized. Earlier this year a request for input on this relevant topic has been sent out by the OECD and a lot of commentators have provided their input. Specifically, on the assessment of the service for the service provider on the one hand and the service recipient on the other. Has the service been provided and what is the benefit of the service for the recipient?
In its guidance, the OECD had already provided the ‘simplified approach’ for so-called low value-add services. Clarifying how a proper charge-out process should be set-up so conforming charge-outs would not be challenged. This process can be improved by a link to the financial statements of the company. This way an audit trail is created that should meet the test that a service has been provided. Based on current guidance, only an invoice should additionally be issued at the end of the year to conclude that the service recipient benefitted from the service. The process could be further enhanced by prescribing that the shareholder costs will be carved-out as a step between the relevant costs and the allocation process. This should be done diligently to demonstrate to stakeholders in the process that only qualifying costs are charged out.
Process description of charging centralized services
From cost center of the provider to invoice and journal entry by recipient; full cycle
Commentator comments and my suggestions:
– Starting from the cost center of the provider ensures that a proper audit trail can be built. External auditors and management should vouch for the books of the company.
– Determination of relevant costs, qualification and allocation of costs to service recipients as well as the determination of the up-lift fall in the Transfer Pricing domain.
– The intra-group services qualifying under the simplified approach should be extended to also include high-value add services – such as senior management and strategy – with a safe-haven mark-up of perhaps 8%. Ensuring that all centralised services can qualify under the simplified approach.
Of course, the input from the commentators will be discussed in further detail at the OECD. An outcome along the lines as described above, would enable MNE’s to further streamline their operations and create the desired insight for Tax Authorities.
Tax audits take up a lot of time and typically cost a considerable amount of money. Setting up a process that ties back to the financial statements provides for clear, reproducible insights.
If the outcomes of the process are reproducible, the process itself is ready for automation. Built on a proper process, an automated solution would ensure centralized storage for easy retrieval and less dependency on individuals who have built a specific Excel environment. Not only for consistency, cost-efficiency and control purposes but most importantly for continuity. Overall, a solution for intra-group services can be created that should stand the test of time.
Are you interested in enhancing your process for charging-out of centralized services, or would you like to know more on taking the next step on automating intercompany charge-outs; let’s talk!